Capital Investment Evaluation
a. Cash flow of the project:
|
Year |
0 |
1 |
2 |
3 |
4 |
5 |
|
Initial investment |
$ (40,000,000) |
|||||
|
Sale of old machine |
$ 5,000,000 |
|||||
|
Revenues ($) |
$ 8,000,000 |
$ 8,000,000 |
$ 8,000,000 |
$ 8,000,000 |
$ 8,000,000 |
|
|
Operating costs ($) |
$ 2,000,000 |
$ 2,000,000 |
$ 2,000,000 |
$ 2,000,000 |
$ 2,000,000 |
|
|
Other costs ($) |
$ 500,000 |
$ 500,000 |
$ 500,000 |
$ 500,000 |
$ 500,000 |
|
|
depreciation |
$ 4,000,000 |
$ 4,000,000 |
$ 4,000,000 |
$ 4,000,000 |
$ 4,000,000 |
|
|
Salvage value |
$ 21,000,000 |
|||||
|
Profit |
$ 1,500,000 |
$ 1,500,000 |
$ 1,500,000 |
$ 1,500,000 |
$ 22,500,000 |
|
|
Tax |
$ 450,000 |
$ 450,000 |
$ 450,000 |
$ 450,000 |
$ 6,750,000 |
|
|
PAT |
$ 1,050,000 |
$ 1,050,000 |
$ 1,050,000 |
$ 1,050,000 |
$ 15,750,000 |
|
|
Cash flow |
$ (35,000,000) |
$ 5,050,000 |
$ 5,050,000 |
$ 5,050,000 |
$ 5,050,000 |
$ 19,750,000 |
|
Discounted cash flow |
$ 0.87 |
$ 0.76 |
$ 0.66 |
$ 0.57 |
$ 0.50 |
|
|
$ 4,391,304.35 |
$ 3,818,525.52 |
$ 3,320,456.97 |
$ 2,887,353.89 |
$ 9,819,240.52 |
||
|
NPV |
$ (10,763,118.75) |
|||||
|
NPV |
$ (10,763,118.75) |
|
Year |
0 |
1 |
2 |
3 |
4 |
5 |
|
Cash flow |
$ (35,000,000) |
$ 5,050,000 |
$ 5,050,000 |
$ 5,050,000 |
$ 5,050,000 |
$ 19,750,000 |
|
Discounting rate |
$ 0.87 |
$ 0.76 |
$ 0.66 |
$ 0.57 |
$ 0.50 |
|
|
Discounted cash flow |
$ 4,391,304.35 |
$ 3,818,525.52 |
$ 3,320,456.97 |
$ 2,887,353.89 |
$ 9,819,240.52 |
|
|
NPV |
(4,391,304.35+3,818,525.52+3,320,456.97+2,887,353.89+9,819,240.52)- 35,000,000 |
|||||
|
NPV |
$ (10,763,118.75) |
The overall NPV of the propjet is relatively negative, which directly indicates that the company will not accept to invest in the new ship.
a. Commenting the performance of each company in relation to the category analysis:
i. Asset management efficiency:
The evaluation of above figure mainly depicts relevant asset management condition of the both AA company and BB Company. In addition, the overall total asset turnover and accounts receivable turnover of AA Company is relatively better than BB Company and industry average. Furthermore, the inventory turnover ratio of both the companies is not according to industry average, whole BB Company is relatively close.
ii. Short term solvency:
The short term solvency condition of AA Company is not relevant, as its debt ratio is higher than industry average and times interest earned ratio is less that industry average. However, BB Company’s solvency condition is in better stage, as it has a more financially stable outlook.
iii. Financial leverage:
Mover, the current ratio of AA Company is better than industry average, while the quick ratio is not adequate to industry average, which indicates the high inventory accumulation conducted by the company. On the other hand the BB Company’s overall current ratio is same as industry average, while the quick ratio is relatively higher indicating the low accumulation of inventory conducted by the company.
iv. Profitability:
From the evaluation of the profitability ratio the overall BB Company’s profits are identified to be adequate, as the company is realizing increasing net profit margin. This indicates that company is earning exponential income from its operations. On the other hand, AA company has low net profit margin, while the return on assets and equity is relevantly higher, which is due to the low accumulation of assets and equity by the company.
The evaluation indicates that BB Company’s overall share margin performance is relatively higher, as its dividend per share and EPS is relatively higher than AA Company. This indicates that share market performance of BB Company is relatively higher than AA Company.
After evaluating the solvency and leverage condition of AA Company, which is relatively in dire conduction the Bank will not pass the loan. This is mainly due to the weak financial position of the AA company, as it not able to generate the required level of profits.
a. Explaining the source of finance for the company to raise money:
The different sources of finance, which could be used by the company are Bank loan, Hire purchase and Lease finance for the equipments purchase.
b. Evaluating the advantages and disadvantages of each investment option:
Investment in shares:
Investment in shares could mainly provide higher return from investment, whereas the risk is relatively higher due to volatile capital market.
Lodging a fixed deposit at a bank:
The fixed deposit at bank could provide a steady low income from investment, whereas there is a limitation, which directly blocks the capital for the fixed tenure and cannot be used for another investment.
Purchase of commercial bills:
Purchase of commercial bills could eventually help in generating high level of return from investment, whereas the risk is relatively higher as it is an unsecured promissory note, whose payment assurance is not guaranteed.
c. Critically evaluating the statement regarding corporate capital:
The statement mainly depicts the use of higher debt and low equity allows the organisation to reduce the overall cash outflow in form of tax. This relevant increment in the debt could allow the company to get exceptions from tax and reduce the overall cash outflow of the organisation.
Identifying and explaining the risk faced by company specific instruments use control the risks:
The major risk of the company is rising debt and expenses, which conducted by the company with the risk from rising debt and currency rate fluctuation could be identified. The relevant control such as low debt accumulation and hedge processing could be used by the company to decline the rising from investment.
Depicting the best strategy for the company to avoid receiving least amount A$ by hedging the exchange rate:
|
No hedge process |
Amount |
US$ |
$A |
|
Receive payment |
$ 500,000.00 |
||
|
Spot exchange |
AUD 655,479.81 |
$ 0.7628 |
$ 1.3110 |
|
3 month exchange rate |
AUD 623,130.61 |
$ 0.8024 |
$ 1.2463 |
|
Loss in currency exchange |
AUD (32,349.20) |
|
90-day forward rate hedge |
Amount |
US$ |
$A |
|
Receive payment |
$ 500,000.00 |
||
|
Spot exchange |
AUD 655,479.81 |
$ 0.7628 |
$ 1.3110 |
|
90-day forward rate |
AUD 638,732.75 |
$ 0.78 |
$ 1.2775 |
|
Loss in currency exchange |
AUD (16,747.06) |
|
Call option 90 day hedge |
Amount |
US$ |
$A |
|
Receive payment |
$ 500,000.00 |
||
|
Spot exchange |
AUD 655,479.81 |
$ 0.7628 |
$ 1.3110 |
|
3 month exchange rate |
AUD 623,130.61 |
$ 0.8024 |
$ 1.2463 |
|
Call option 90 day |
AUD 625,000.00 |
$ 0.80 |
$ 1.2500 |
|
Loss in currency exchange |
AUD (30,479.81) |
From the overall evaluation of hedging process for both forward rate hedging and option hedging viability can be identified. In addition, the relevant loss from forward rate exchange rate is relatively lower than the option hedging process. Addison (2017) mentioned that evaluation of the adequate hedging strategy directly help in improving profitability of the company. Therefore, with the use of 90 day forward rate relevant reduction in losses could be obtained, as it portrays the least losses in comparison to other hedging process.
|
Particulars |
Value |
|
Tax |
30% |
|
Ordinary shares |
5,000,000 |
|
Share price |
20 |
|
Dividend per share |
1 |
|
Equity value |
100,000,000 |
|
cost of equity |
5.0% |
|
Coupon rate |
6% |
|
Yield |
8% |
|
Debentures |
20,000,000 |
|
Total |
120,000,000 |
|
cost of debt |
6% |
|
Total |
220,000,000 |
|
WACC |
4.56% |
|
Risk free rate |
5% |
Market portfolio |
11% |
|
|
Share |
Beta |
Expected return |
Return for stock |
Comment |
|
A |
1.33 |
12% |
= 5%+1.33*(11%-5%) = 12.98% |
Overpriced |
|
B |
0.7 |
10% |
= 5%+0.77*(11%-5%) = 9.20% |
Underpriced |
|
C |
1.5 |
14% |
= 5%+1.5*(11%-5%) = 14.00% |
fairly priced |
|
D |
0.66 |
9% |
= 5%+0.66*(11%-5%) = 8.96% |
Underpriced |
References
Addison, P.S., 2017. The illustrated wavelet transform handbook: introductory theory and applications in science, engineering, medicine and finance. CRC press.
Embrechts, P., Klüppelberg, C. and Mikosch, T., 2013. Modelling extremal events: for insurance and finance (Vol. 33). Springer Science & Business Media.
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