Finance project - Assignment Example

An analysis of the financial forecasts presented gives an insight into the financial requirements of the project. Suitable methods of project evaluation such as Net Present Value method, Internal rate of Return and Profitability Index approaches can be used to evaluate this project. Decision making by the Board of Directors can be based on one, two or all of the above methods. Determination of the cost of capital is significant as this will give the discounting rate to be used to discount the cash flows expected from the project.

A rate of 8 percent is determined using the dividend growth rate model. This rate is adjusted to incorporate the risk factor present in the business. The risk adjusted discounting rate is therefore 11 percent. Depreciation is calculated using the MACRS approach of General Depreciation System. The rates are as prescribed in Table A-1 (US Treasury 946). A depreciation tax shield is calculated based on the depreciation values and this is added back as a benefit. The NPV approach gives a Net Present Value of $ 20,893,000.

Therefore, the project should be implemented as it promises a positive NPV. Financially, the project is viable. If the funds obtained were non-interest bearing, the project would be financially viable under this approach. Under the Internal Rate of Return method, the PV of all future incomes are compared against the Initial investment and the discounting rate which equates the two represents the IRR. It is that discounting rate which yield a zero NPV. From the financial data obtained, the rate is determined as 11.48%. This is above the investors’ required rate of 8% and the risk adjusted rate of 11%.

The project therefore will generate a higher return and should therefore be implemented. Using the Profitability index approach, the PI of the project is more than 1 and therefore viable. It yields a PI of 1.16. The project should therefore be implemented on this