Financial Analysis Of CWC’s Bottled Water Project

Determining the Weighted Average Cost of Capital for CWC

a.Value of shares = 30,000,000 * $ 42 = $ 1260,000,000

Computation of WACC for CWC

Cost of equity –

K_e = R_f  + β (R_m – R_f) (Pricing and Tribunal 2013)

Where,

K_e = cost of equity

R_m = Market return = 12.52%

R_f  = Risk free rate = 3.5%

Β = Beta = 2.639

Hence,

K_e = 3.5 + 2.639 * (12.52 – 3.5)

      = 3.5 + 23.8038 = 27.3038%

Therefore, cost of equity or K_e = 27.3038%

Cost of bond –

Present value = 50,00,000 * $ 92.34 = $ 46,17,00,000

Face value = 50,00,000 * 100 = 50,00,00,000

Annual interest rate = 10% * 2 = 20%

Maturity = 20 years

Interest per year = 50,00,00,000 * 20% = $ 10,00,00,000

After tax interest = $ 10,00,00,000 * (1-0.34) = $ 660,00,000

Therefore, the effective rate = $ 660,00,000 / $ 50,00,00,000 = 0.132 or 13.20%

Cost of capital – (Grüninger and Kind 2013)

Therefore, the weighted average cost of capital = 23.52%

b.Computation of depreciation amount –

Value of project = $ 30,00,000

Salvage value = Nil

Useful life = 3 years

Depreciation method used = Straight line

Therefore, depreciation = $ 30,00,000 / 3 = $ 10,00,000 per year

Net present value –

= Present value of cash flows – Initial outlay

= $ 22,53,770.40 – $ 30,00,000 = – $ 746,222.60

Any project is not acceptable if the NPV of the project is in negative. As it is seen from the above computation that the resultant NPV from the proposed project of bottled water is negative that is amounted to – $ 746,222.60. Hence, the project is not acceptable under current scenario (Harrison and Lock 2017).

c.Best – case scenario

Net present value –

= Present value of cash flows – Initial outlay

= $ 39,50,083.15 – $ 30,00,000 = $ 950,083.15

Any project is acceptable if the NPV of the project is positive. As it is seen from the above computation that the resultant NPV from the proposed project of bottled water is positive that is amounted to $ 950,083.15. Hence, the project is acceptable under the best case scenario (Leyman and Vanhoucke 2016).

Worst – case scenario

Net present value –

= Present value of cash flows – Initial outlay

= $ 19,04,634.86 – $ 30,00,000 = – $ 10,95,365.15

Any project is not acceptable if the NPV of the project is in negative. As it is seen from the above computation that the resultant NPV from the proposed project of bottled water is negative that is amounted to – $ 10,95,365.15. Hence, the project is not acceptable under worst case scenario (Gallo 2014). 

d.Net present value or NPV is the difference among present value of any investment’s anticipated cash inflows reduced by the initial outlay. NPV is considered as most appropriate for valuation of any project as it takes into account the time value of the money (Pasqual, Padilla and Jadotte 2013). The project with positive NPV is considered to be acceptable and on the contrary, the project with negative NPV is considered as not acceptable (Larson and Gray 2013). Therefore, as the financial analyst before suggesting any project the needs and preference regarding return and initial investment amount of the client must be analysed and taken into consideration (San Ong and Thum 2013).

From above computation of the expected NPV under stated normal condition, under Best case scenario and under worst case scenario it is identified that –

• NPV under normal condition is negative and amounted to -$ 746,222.60
• NPV under Best case scenario is positive and amounted to $ 950,083.15
• NPV under Worst case scenario is negative and amounted to -$ 10,95,365.15

Hence, the proposed project of bottled water is acceptable only under best case scenario. Therefore, CWC shall continue with the proposed bottled water project under best case scenario and under normal condition as well as worst case scenario the project is not acceptable. 

References

Gallo, A., 2014. A refresher on net present value. Harvard Business Review, 19.

Grüninger, M.C. and Kind, A.H., 2013. WACC calculations in practice: Incorrect results due to inconsistent assumptions-status quo and improvements. Accounting and finance research, 2(2), p.36.

Harrison, F. and Lock, D., 2017. Advanced project management: a structured approach. Routledge.

Larson, E. W., and Gray, C., 2013. Project management: The managerial process with MS project. McGraw-Hill.

Leyman, P. and Vanhoucke, M., 2016. Payment models and net present value optimization for resource-constrained project scheduling. Computers & Industrial Engineering, 91, pp.139-153.

Pasqual, J., Padilla, E. and Jadotte, E., 2013. Equivalence of different profitability criteria with the net present value. International Journal of Production Economics, 142(1), pp.205-210.

Pricing, I. and Tribunal, R., 2013. Review of WACC methodology. Research–Final report.

San Ong, T. and Thum, C.H., 2013. Net present value and payback period for building integrated photovoltaic projects in Malaysia. International Journal of Academic Research in Business and Social Sciences, 3(2), p.153.

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