The Finance - Case Study Example

CASE STUDY IN FINANCE Problem 1: Development of a spreadsheet model representing the cash flows associated with the power station project, and the assessment of the project using a range of capital budgeting evaluation techniques. Part 1: has been done in spreadsheet. Refer to the attached alongside excel sheet Part 2: Assessment of the project using a range of capital budgeting evaluation techniques Technique 1: Using Net present value, Where CF-Net cash flow year n r is the discounting rate( either nominal or real) n is the number of years ICO is initial capital outlay Sum of present value of net cash flows is 3,626.56, while the present value of investment expenditure is 776.36 Hence NPV= 3626.56-776.36=2,850.2 Technique 2: Use of profitability index Hence: Profitability Index is= 3626.56/776.36=4.67 Technique 3 Use of payback method Years of project implementation 0 1 2 3 4 5 Yearly Cash flow -1002.5 191.49 172.74 399.10 409.23 409.23 Cumulative cash flow -1002.5 (811.01) (638.27) (239.17) 170.06   From the spreadsheet Hence the payback period will be (3+ (239.17/409.23))= 3.58 years Problem 2: The completion of a risk assessment based on conducting sensitivity analysis of the project valuation focusing on key parameters impacting on the project’s operation, feasibility and cash flows. Iloiu M., & Csiminga D.(n.d) sensitivity analysis is a test subjected to NPV responsiveness in regard to a change in a key project parameter. For this case, I choose Initial capital outlay, Price per power unit and operating and Maintenance cost to test on NPV Sensitivity. i) Initial capital outlay –increase by 20% due to unplanned changes in prices of inputs in the market. ii) Price per Megawatt hour- reduces by 20% just in case of reduced demand of power due to customers using alternative power sources or due to competition. iii) Operating and Maintenance costs- increase by 20% due to fluctuation on prices of inputs, price of, and availability of labour. Sensitivity analysis towards the NPV Where: Si- Sensitivity Indicator, NPVb - base NPV, NPV1 - the sensitivity test NPV variable value, Xb- Base value of Variable, X1-is the sensitivity test value of variable Scenario 1: For Increase by 20% of ICO: NPVb-2850.20, NPV1- 2694.93, Xb-776.36, X1-931.64, SI is -0.272 Scenario 2: For reduction of price per MW by 20%: NPVb-2850.20, NPV1-1973.17, Xb-194.18, X1-155.344, SI is 1.538 Scenario 3: Increase by 20% in operating and maintenance costs: NPVb-2850.20, NPV1-2698.49, Xb-3788.5, X1-4546.2, SI is -0.266 Switching value (SV), which is the percentage reciprocal of the sensitivity factor is vital to calculate. It gives the percentage change in the variable under consideration to reduce the NPV to zero. Find summary in the table below Item Change NPV SI (NPV) SV (NPV) Base case 0 2,850.20     Investment( ICO) Increase by 20% 2,694.93 -0.272389566  367.24% Price per MW Decrease by 20% 1,973.17 1.53853097  65% Operating and Maintenance costs Increase by 20% 2,698.49 -0.266141405  375.80%           Problem 3: Base on the project Modelling and sensitivity analysis, a recommendation as to the feasibility of the project. To respond to this problem, one has to interpret the findings from NPV, Pi, payback period, SI and SV Basing on NPV, it is a strong positive number (2850.2) indicating the project is viable. Basing on Profitability Index- It is strong greater than one number (4.67), indicating that the project is viable Basing on payback period, it will take the 3.58 years, pay off the initial capital expenditure meaning the project will break even at after three years of its 35 year life. This indicates that the project is viable Use of Sensitivity analysis -Scenario one: Increasing cost of investment by 20% leads to a sensitivity indicator of negative 0.27, meaning that change of 20% in investment cost will result to (20*(-.27)) negative 5.4% reduction in the Economic Net Present value (ENPV).The lower the SI the less sensitive the NPV to the to the variable being tested hence for our case, the NPV is very irresponsive to change in increase in cost of investment. Scenario 2: Reducing the cost of power per MW/hr by 20% leads to a SI indicator of 1.54 meaning that, a reduction of 20% in price per MW/hr will result to (20*1.54) 30.6% change in Economic Net Present Value (ENPV). For this case, the NPV is slightly responsive to reduction of price per MW/hr meaning that, even when the demand for power is adversely affected and results to a price reduction by 20%, the project will still be viable. Scenario 3: Increase in operating and maintenance costs by 20% results into SI indicator of negative 0.27 which be interpreted as of scenario 1. The Switching value for Scenario 1 is very high (367.24%) meaning that a change (increase) of 367.24% in the variable being tested will cause the ENPV to become zero. The higher the switching value, the less sensitive is the NPV to the changes in the variable under reference and the less risky project is. Recommendation Recommendation, by use of NPV, Payback period and Profitability index project budgeting evaluation techniques, the project is viable and is strongly recommended to be undertaken. Using the sensitivity analysis, none-of the variables selected point out to high exposure to risk in case of changes on the variable. Only reduction of price per MW/hr by 20% showed slight responsiveness, but not lethal. Meaning that changes in the variables selected will not adversely affect the performance of the project as a result; I recommend the project to be undertake for it is viable and less risky. Problem 4: The preparation of a proposal for the respective Governments providing justification for why approval for the project should be provided La Trobe Valley project Proposal justification Introduction Engie group, the owners of the successful Loy Yang B power project would like to undertake a coal powered power station project in La Trobe Valley in South-Eastern Victoria. This has been informed by the following reasons: 1. Existence of coal in la Trobe valley upon whose exploitation would create employment to the people and revenue to the Government through taxes. 2. Existence of none-competing company supplying alternative power in the country hence with increase in population, demand for power would commensurately increase hence the project addresses such a challenge proactively. 3. The growth of industrial sector, which is mutually absorbing more employees in the wake of every day require sufficient power supply, hence the company has put this into consideration and purposed to expand its operations to cater for the would be shortfall in power supply. 4. The life of Loy Yang B project is coming to an end in 2025 rhyming with the exact time the new station will be commissioned to enable the country have a smooth transition of power supply. 5. The project takes into consideration issues of pollution through emission, and the company plans to use ultramodern power devises with very minimal pollution to the environment hence contributing towards the government’s call for sustainable environment. 6. Once more, the company will create a buffer zone with a radius of a kilometer to cushion citizens from any unpreceded effects to human health. Considering the basis of the project above, we make our humble request to your honorable Government for approval for of the project. REFERENCES Iloiu M., & Csiminga D.(n.d). Project risk evaluation methods - sensitivity analysis. Retrieved on September 8, 2016 from site: http://www.findpdfdoc.com/pdf_sensitivity analysis Payback period. Retrieved on September 8, 2016 from site: http://www.investopedia.com/terms/p/paybackperiod.asp Read More