Part 1: Cost of Capital of Aust Capital Supplies
|
Return Rate of Unsecured Notes: |
|
|
Particulars |
Amount |
|
Current Trading Price |
$980 |
|
Maturity Period (in years) |
11 |
|
Nos. of Coupon Payment |
22 |
|
Semi-Annual Coupon Payment |
$40 |
|
Rate of Return |
1.01% |
|
Annualized Rate of Return |
2.02% |
|
Return Rate of Debentures: |
|
|
Particulars |
Amount |
|
Current Market Price |
$1,115 |
|
Face Value |
$1,000 |
|
Maturity Period (in years) |
8 |
|
Nos. of Coupon Payment |
8 |
|
Annual Coupon Payment |
$110 |
|
Rate of Return |
8.93% |
|
Return Rate of Preference Shares: |
|
|
Particulars |
Amount |
|
Preference Dividend |
$12.10 |
|
Current Market Price |
$97.50 |
|
Rate of Return |
12.41% |
|
Computation of Cost of Equity: |
||||||
|
Period |
||||||
|
Particulars |
0 |
1 |
2 |
3 |
4 |
5 |
|
Growth Rate |
10.20% |
10.20% |
10.20% |
4% |
3% |
|
|
Dividend per Share |
$4.34 |
$4.78 |
$5.27 |
$5.81 |
$6.04 |
$6.22 |
|
Fair Stock Price at year 4 |
61.086331 |
|||||
|
Calculated Current Price |
$53.25 |
|||||
|
Cost of Equity |
13.185% |
|
Computation of WACC: |
||||||
|
Particulars |
Total Units |
Market Price |
Total Amount |
Weightage |
Rate of Return |
Weighted Return |
|
Preferred Stock |
2500 |
$97.50 |
$243,750 |
6.14% |
12.41% |
0.76% |
|
Ordinary Shares |
70000 |
$53.25 |
$3,727,500 |
93.86% |
13.185% |
12.38% |
|
Total Share Capital |
$3,971,250 |
100% |
13.14% |
|||
|
Unsecured Note |
1000 |
$980 |
$980,000 |
49.41% |
2.02% |
1.00% |
|
Debentures |
900 |
$1,115 |
$1,003,500 |
50.59% |
8.93% |
4.52% |
|
Total Debt Capital |
$1,983,500 |
100% |
5.52% |
|||
|
WACC: |
||||||
|
Share Capital |
$3,971,250 |
66.69% |
13.14% |
8.76% |
||
|
Debt Capital |
$1,983,500 |
33.31% |
5.52% |
1.84% |
||
|
Tax Rate |
27.50% |
|||||
|
Total Capital |
$5,954,750 |
100% |
10.09% |
|
Period |
||||||
|
Particulars |
0 |
1 |
2 |
3 |
4 |
5 |
|
WACC |
10.09% |
10.09% |
10.09% |
10.09% |
10.09% |
10.09% |
|
Required Rate of Return |
8.09% |
8.09% |
8.09% |
8.09% |
8.09% |
8.09% |
|
Inflation Rate |
2% |
2% |
2% |
2% |
2% |
2% |
|
Initial Investment: |
||||||
|
Cost of Machinery |
($1,000,000) |
|||||
|
Refurbishing of Plant |
($500,000) |
|||||
|
Cost of Land |
($89,152) |
|||||
|
Total Initial Investment |
($1,589,152) |
|||||
|
Net Operating Cash Flow: |
||||||
|
Annual Sales (in unit) |
100000 |
100000 |
100000 |
100000 |
100000 |
|
|
Selling Price per unit |
$30 |
$30 |
$30 |
$30 |
$30 |
|
|
Total Sales |
$3,000,000 |
$3,000,000 |
$3,000,000 |
$3,000,000 |
$3,000,000 |
|
|
Cost of Goods Sold: |
||||||
|
Variable Cost per unit |
$18.00 |
$18.36 |
$18.73 |
$19.10 |
$19.48 |
|
|
Total Variable Costs |
($1,800,000) |
($1,836,000) |
($1,872,720) |
($1,910,174) |
($1,948,378) |
|
|
Fixed Costs |
($300,000) |
($306,000) |
($312,120) |
($318,362) |
($324,730) |
|
|
Total Cost of Goods Sold |
($2,100,000) |
($2,142,000) |
($2,184,840) |
($2,228,537) |
($2,273,108) |
|
|
Gross Profit |
$900,000 |
$858,000 |
$815,160 |
$771,463 |
$726,892 |
|
|
Depreciation on Machinery |
($200,000) |
($200,000) |
($200,000) |
($200,000) |
($200,000) |
|
|
Depreciation on Plant |
($50,000) |
($50,000) |
($50,000) |
($50,000) |
($50,000) |
|
|
Net Profit before Tax |
$1,150,000 |
$1,108,000 |
$1,065,160 |
$1,021,463 |
$976,892 |
|
|
Income Tax @27.5% |
($316,250) |
($304,700) |
($292,919) |
($280,902) |
($268,645) |
|
|
Net Profit after Tax |
$833,750 |
$803,300 |
$772,241 |
$740,561 |
$708,247 |
|
|
Add: Depreciation |
$250,000 |
$250,000 |
$250,000 |
$250,000 |
$250,000 |
|
|
Less: Change in Working Capital |
($300,000) |
$0 |
$0 |
$0 |
$0 |
|
|
Net Operating Cash Flow |
$783,750 |
$1,053,300 |
$1,022,241 |
$990,561 |
$958,247 |
|
|
Terminal Value: |
||||||
|
Expected Selling Price of Land & Plant |
$600,000 |
|||||
|
Sale of Machinery |
$0 |
|||||
|
Terminal Value |
$600,000.0 |
|||||
|
Net Cash Flow |
($1,589,152) |
$783,750 |
$1,053,300 |
$1,022,241 |
$990,561 |
$1,558,247 |
|
Discounted Cash Flow |
($1,589,151.92) |
$725,067.38 |
$901,475.05 |
$809,386.10 |
$725,578.50 |
$1,055,942.78 |
|
Net Present Value |
$2,628,297.89 |
The submission of bid for the competitive tender to Australian Defense supplies will be determined by the employment of capital budgeting techniques that helps in determination of feasibility and viability of project. Determining the submission of bid is evaluated by applying the concepts of net present value that is one of the tool of capital budgeting. Investors make use of net present value in evaluation of project that is whether the project should be accepted or rejected (Hise et al., 2016). For the analysis purpose, this particular method make use of discounted cash flows along with considering time variables and risks. The forecasted cash flow is evaluated by discounting them to present value using appropriate cost of capital considering project time span. From the above table, it can be seen that the initial cost of investments stood at $ 1589152. Cost of capital is assumed to be at 8.09% and inflation rate is assumed to be at 2%. However, the rate of inflation and cost of capital is assumed to be constant through the time span of project. Time span of project is consideredfive years. Value of sales is also assumed constant throughout project life. Terminal vale of project is calculated or estimated to be at $ 600000. It is clearly depicted from above table that net cash flow of project in the first year of operation is stood at $ 783750. Value of net cash flow delivered increased initially until second year of operation. Net cash value declined in third year of operation to $ 1022241. Nonetheless, last year of operation generate highest estimated net cash flow that stood at $ 1558247. The net present value of project after discounting present cash flow using the discounted rate or cost of capital provided is $ 2628297.89 and this figures represents that the project has generated positive net present value. As per the decision rule of net present value, it is said that investor should reject the project that generates negative net present value and should accept it when it generates positive net present value. Therefore, as per the decision rule, bid should be submitted to Navy as project has generated positive net present value.
|
Period |
|||||||
|
Particulars |
0 |
1 |
2 |
3 |
4 |
5 |
6 |
|
WACC |
10.09% |
10.09% |
10.09% |
10.09% |
10.09% |
10.09% |
10.09% |
|
Initial Investment: |
|||||||
|
Cost of New Machinery |
$1,200,000 |
||||||
|
Less: Sale of Old Machinery |
$46,000 |
||||||
|
Net Investment Required for Purchasing New Machine |
$1,154,000 |
||||||
|
Add: Increase in Inventory |
$300,000 |
||||||
|
$1,454,000 |
|||||||
|
Less: Increase in Accounts Payable |
$100,000 |
||||||
|
Total Initial Investment |
($1,354,000) |
||||||
|
Annual Operating Cash Flow: |
|||||||
|
Current Output |
$111,080 |
$111,080 |
$111,080 |
$111,080 |
$111,080 |
$111,080 |
|
|
Increase in Output |
$11,500 |
$12,500 |
$14,000 |
$14,000 |
$14,000 |
$14,000 |
|
|
Selling Price per Unit |
$21 |
$21 |
$21 |
$21 |
$21 |
$21 |
|
|
Savings in Operating Cost per unit |
$1.50 |
$2.25 |
$2.25 |
$2.25 |
$2.25 |
$2.25 |
|
|
Depreciation of Current Machine |
$200,000 |
$200,000 |
$200,000 |
$200,000 |
$200,000 |
$200,000 |
|
|
Depreciation of Old Machine |
$71,667 |
$71,667 |
$71,667 |
$71,667 |
$71,667 |
$71,667 |
|
|
Increase in Sales Income |
$241,500 |
$262,500 |
$294,000 |
$294,000 |
$294,000 |
$294,000 |
|
|
Savings og Operating Income |
$166,620 |
$249,930 |
$249,930 |
$249,930 |
$249,930 |
$249,930 |
|
|
Increase in Depreciation |
($128,333) |
($128,333) |
($128,333) |
($128,333) |
($128,333) |
($128,333) |
|
|
Net Incremental Profit |
$279,787 |
$384,097 |
$415,597 |
$415,597 |
$415,597 |
$415,597 |
|
|
Less: Income Tax |
($76,941) |
($105,627) |
($114,289) |
($114,289) |
($114,289) |
($114,289) |
|
|
Net Incremental Profit after Tax |
$202,845 |
$278,470 |
$301,308 |
$301,308 |
$301,308 |
$301,308 |
|
|
Add: Additional Depreciation |
$128,333 |
$128,333 |
$128,333 |
$128,333 |
$128,333 |
$128,333 |
|
|
Net Incremental Operating Cash Flow |
$331,179 |
$406,803 |
$429,641 |
$429,641 |
$429,641 |
$429,641 |
|
|
Terminal Value: |
|||||||
|
Estimated Salvage Value of New Machine |
$150,000 |
||||||
|
Total Terminal Value |
$0 |
$0 |
$0 |
$0 |
$0 |
$150,000 |
|
|
Net Annual Cash Flow |
($1,354,000) |
$331,179 |
$406,803 |
$429,641 |
$429,641 |
$429,641 |
$579,641 |
|
Discounted Cash Flow |
($1,354,000.00) |
$300,816.09 |
$335,630.95 |
$321,974.71 |
$292,455.95 |
$265,643.49 |
$325,530.20 |
|
Net Present Value |
$488,051.39 |
A company is required to purchase a replacement machine for making products and probable utensils for mobile uses. An initial investment made by company in purchasing machinery is $ 1200000 for which the estimated useful life is assumedsix years. Salvage value is estimated to be at $ 150000. Initial amount of investment takes into consideration the accounts payable value that is deducted and increase in value of inventory that is added and adjustment is made to investment value (Hasan, 2013). Undertaking of replacement by company is evaluated by applying the techniques of capital budgeting. For determining the net present value, cost of capital of project is assumed to be at 10.09%. Net present value takes into account cost of capital of project and net cash flow for determining the feasibility (Burns & Walker, 2015).
Part 2: Competitive Bid for a Contract to Supply Duffel Canvas to the Australian Navy
From the above table, it can be seen that estimated profit of project is initially increasing and eventually it remains constant in the later year of operation. The value remained constant at $ 415597. Operating cash flow also witnessed an increase in its initial year and becomes constant in later year. Net annual cash flow increased continuously throughput the life of machinery. Now, discounting the value of net anal cash flow each year using the appropriate discount rate, that is 10.09% in the given case, net present value of replacing the machinery is estimated or projected. Net present value of machinery purchased by company is calculated at $ 488051. 39. From the figure, it is clear that replacing the machinery would lead to positive net present value. Therefore, company should undertake replacement.
However, there are factors that can considerable impact on recommendation provided. Such factors are mostly macro-economic variables such as inflation, policy of government. For determining required rate of return, company is not required to include inflation. Calculation of cash flow needs to include rate of changes in inflation. Therefore, assuming constant inflation rate is not feasible.Furthermore, there can be variation in assumed cost of capital due to changes in macro-economic factors. Political risk is another factor that needs to be considered as it has considerable role in affecting the project’s possibility. These involve taxation, environmental factors and convertibility of currency. Economic viability of project is also affected by environment in which the company is operating and this can have substantial impact on cost incurred in executing the project and therefore its profitability.
Reference:
Ahmed, I. E. (2013). Factors determining the selection of capital budgeting techniques. Journal of Finance and Investment Analysis, 2(2), 77-88.
Andor, G., Mohanty, S. K., &Toth, T. (2015). Capital budgeting practices: A survey of Central and Eastern European firms. Emerging Markets Review, 23, 148-172.
Burns, R., & Walker, J. (2015). Capital budgeting surveys: the future is now.
Guerra, M. L., Magni, C. A., &Stefanini, L. (2017). Average internal rate of return with interval arithmetic.
Hall, J. H., &Mutshutshu, T. (2013). Capital budgeting techniques employed by selected South African state-owned companies.
Hasan, M. (2013). Capital budgeting techniques used by small manufacturing companies. Journal of Service Science and Management, 6(01), 38.
Hise, R. T., &Strawser, R. H. (2013). Application of Capital Budgeting Techniques to Marketing Operations. Readings in Managerial Economics: Pergamon International Library of Science, Technology, Engineering and Social Studies, 419.
Mendes-Da-Silva, W., & Saito, R. (2014). Stock exchange listing induces sophistication of capital budgeting. Revista de Administração de Empresas, 54(5), 560-574.
Mukherjee, T. K., & Al Rahahleh, N. M. (2013). Capital budgeting techniques in practice: US survey evidence. Capital Budgeting Valuation: Financial Analysis for Today’s Investment Projects, 151-171.
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