Investment Valuation
|
Particulars |
Amount |
|
|
Payout Ratio |
A |
70% |
|
Share of W.Brown |
B |
12% |
|
Growth Rate of Net Profit |
C |
25% |
|
Interest Rate p.a. |
D |
9% |
|
Net profit after tax on ’16-17 |
D |
$600,000 |
|
Total Dividend Paid on ’16-17 |
E=DxA |
$420,000 |
|
Dividend Received on ’16-17 |
F=ExB |
$50,400 |
|
Net profit after tax on ’17-18 |
H=D*(1+C) |
$750,000 |
|
Total Dividend on ’17-18 |
I=HxA |
$525,000 |
|
Dividend Receivable on ’17-18 |
J=IxB |
$63,000 |
|
PV of Dividends on ’17-18 |
K=J/(1+D)^1 |
$57,798 |
|
Fund Required on ’17-18 |
L |
$100,000 |
|
PV of Fund Required |
M=L/(1+D)^1 |
$91,743 |
|
Consumption in August’17 |
N=F-(M-K) |
$16,455 |
|
Periods |
|||||
|
Particulars |
0 |
1 |
2 |
3 |
4 |
|
t0 |
t1 |
t2 |
t3 |
t4 |
|
|
Dividend Growth Rate |
0% |
20% |
15% |
10% |
5% |
|
g0 |
g1 |
g2 |
g3 |
g4 |
|
|
Required Rate of Return |
12% |
12% |
12% |
12% |
12% |
|
r0 |
r1 |
r2 |
r3 |
r4 |
|
|
Dividend |
$1.20 |
$1.44 |
$1.66 |
$1.82 |
$1.91 |
|
D0 |
D1=D0x(1+g1) |
D2=D1x(1+g2) |
D3=D2x(1+g3) |
D4=D3x(1+g4) |
|
|
PV of Dividends for Unstable Period |
$1.29 |
$1.32 |
$1.30 |
||
|
P1=D1/(1+r1)^t1 |
P2=D2/(1+r2)^t2 |
P3=D3/(1+r3)^t3 |
|||
|
Terminal Value of Perpetuity |
$27.32 |
||||
|
T=D4/(r4-g4) |
|||||
|
PV of Terminal Value |
$17.36 |
||||
|
P4=T/(1+r4)^t4 |
|||||
|
Expected Selling of Stocks on August,2017 |
$21.27 |
||||
|
F=P1+P2+P3+P4 |
|
Particulars |
Amount |
|
|
Total Perpetual Scholarship p.a. |
A |
$50,000 |
|
Required Rate of Return p.a. |
B |
5% |
|
Present Value of Perpetuity in 2020 |
C=A/B |
$1,000,000 |
|
Deferred Period |
D |
3 |
|
Present Value of Income Stream on 2017 |
E=C/(1+B)^(D-1) |
$907,029.48 |
|
Particulars |
Amount |
|
|
Total Perpetual Scholarship p.a. |
A |
$50,000 |
|
Required Rate of Return p.a. |
B |
5% |
|
Growth rate of Fees p.a. |
C |
3% |
|
Present Value of Perpetuity in 2020 |
D=A/(B-C) |
$2,500,000 |
|
Deferred Period |
E |
3 |
|
Present Value of Income Stream on 2017 |
F=D/(1+B)^(E-1) |
$2,267,573.70 |
|
Particulars |
Amount |
|
|
Interest Rate p.a. |
A |
7.80% |
|
Compounding Period p.a. |
B |
12 |
|
Effective Annual Interest Rate p.a. |
C=[(1+A/B)^B]-1 |
8.08% |
|
Particulars |
Amount |
|
|
Loan Amount |
A |
$540,000 |
|
Effective Annual Interest Rate p.a. |
B |
8.08% |
|
Compounding Period p.a. |
C |
12 |
|
Total Period (in years) |
D |
20 |
|
Effective Annual Interest Rate per month |
E=B/C |
0.67% |
|
Total nos. of Repayments |
F=BxD |
240 |
|
Amount of Monthly Repayment |
G=(AxE)/[1-(1+E)^-F] |
$4,545.38 |
|
Particulars |
Amount |
|
|
Initial Loan Amount |
A |
$540,000 |
|
Effective Annual Interest Rate per month |
B |
0.67% |
|
Compounding Period p.a. |
C |
12 |
|
FV of Loan after first 12 months |
D=Ax[(1+B)^C] |
$585,313.62 |
|
Monthly Repayments in first 12 months |
E |
$3,300 |
|
FV of Total Repayments in first 12 months |
F=Ex[{(1+B)^C}-1]/B |
$41,100.88 |
|
Balance of Loan after first 12 months |
G=D-F |
$544,212.73 |
|
FV of Balance Loan in next 12 months |
H=Gx[(1+B)^C] |
$589,879.86 |
|
Monthly Repayments in Next 12 months |
I |
$3,750 |
|
FV of Total Repayments in next 12 months |
J=Ix[{(1+B)^C}-1]/B |
$46,705.55 |
|
Balance of Loan after next 12 months |
K=H-J |
$543,174.31 |
|
Total nos. of Repayments |
L |
240 |
|
Balance nos. of Repayments |
M=L-(Cx2) |
216 |
|
Amount of Monthly Repayments from 3rd Year Onwards |
N=(BxK)/[1-(1+B)^-M] |
$4,780.53 |
|
Particulars |
Amount |
|
|
Initial Loan Amount |
A |
$540,000 |
|
Effective Annual Interest Rate per month |
B |
0.67% |
|
Interest Due on first month |
C=AxB |
$3,638.24 |
|
Monthly Repayments |
D |
$2,500 |
|
Interest Due |
E=C-D |
$1,138.24 |
It is clear from the table, by paying monthly installments of $2500, Ron and Robin would not be able to cover the full interest amount for the first month. As the result, the due interest would be added with the principal amount in the next month and subsequently increase the amount of interest in the next month. In this manner, the principal amount would increase in every month and can never be repaid fully with the monthly installment of $2500.
From the above discussion, it can be stated that as the loan cannot be repaid with the monthly payment of $2500, there would be no final repayments.
If it is assumed that the cash flows have occurred in the mid of every year after period 0, then payback periods of the two investments would be as follows:
|
Investment Y |
||||||||
|
Period |
Period |
|||||||
|
Particulars |
0 |
0.5 |
1.5 |
2.5 |
0 |
0.5 |
1.5 |
2.5 |
|
t0 |
t1 |
t2 |
t3 |
t0 |
t1 |
t2 |
t3 |
|
|
Cash Flows |
-40000 |
12000 |
18000 |
27000 |
-40000 |
18000 |
18000 |
18000 |
|
C0 |
C1 |
C2 |
C3 |
C0 |
C1 |
C2 |
C3 |
|
|
Cumulative Cash Flow |
-40000 |
-28000 |
-10000 |
17000 |
-40000 |
-22000 |
-4000 |
14000 |
|
CC0 |
CC1 |
CC2 |
CC3 |
CC0 |
CC1 |
CC2 |
CC3 |
|
|
Payback Period (in years) |
1.87 |
1.72 |
||||||
|
P=t2+(-CC2/C3) |
P=t2+(-CC2/C3) |
From the table, it is clear that Investment Y would have lesser payback period than Investment X and hence, it should be selected for investment purpose.
If the cash flows occurred at the end of each period, then the payback periods would surely differ from the above answer. The payback periods for this alternative scenario are calculated below:
|
Investment X |
Investment Y |
|||||||
|
Period |
Period |
|||||||
|
Particulars |
0 |
1 |
2 |
3 |
0 |
1 |
2 |
3 |
|
t1 |
t2 |
t3 |
t4 |
t1 |
t2 |
t3 |
t4 |
|
|
Cash Flows |
-40000 |
12000 |
18000 |
27000 |
-40000 |
18000 |
18000 |
18000 |
|
C1 |
C2 |
C3 |
C4 |
C1 |
C2 |
C3 |
C4 |
|
|
Cumulative Cash Flow |
-40000 |
-28000 |
-10000 |
17000 |
-40000 |
-22000 |
-4000 |
14000 |
|
CC1 |
CC2 |
CC3 |
CC4 |
CC1 |
CC2 |
CC3 |
CC4 |
|
|
Payback Period (in years) |
2.37 |
2.22 |
||||||
|
P=t3+(-CC3/C4) |
P=t3+(-CC3/C4) |
The table denotes that the payback periods for both the project would extend for further 0.5 years. However, in this scenario also, Investment Y would recover the initial investment faster than Investment X and therefore, it would be better to select investment Y.
NPV is calculated on the basis of present vales of future cash flows, which, in turn, are ascertained with the help of discount rate. The discount rate is generally the required rate of return or the cost of capital for any investment. In this case, no such rates have been mentioned in the case study. Hence, it is not possible to draw any graph for comparing the NPV of the two projects (Mukherjee and Al Rahahleh 2013).
However, the net cash flows, generated from the two projects are calculated and shown in the graph below to compare the two investments:
|
Investment X |
Investment Y |
|||||||
|
Period |
Period |
|||||||
|
Particulars |
1 |
2 |
3 |
4 |
1 |
2 |
3 |
4 |
|
t1 |
t2 |
t3 |
t4 |
t1 |
t2 |
t3 |
t4 |
|
|
Cash Flows |
-40000 |
12000 |
18000 |
27000 |
-40000 |
18000 |
18000 |
18000 |
|
C1 |
C2 |
C3 |
C4 |
C1 |
C2 |
C3 |
C4 |
|
|
Net Cash Flow |
17000 |
14000 |
||||||
|
NPV = C1+C2+C3+C4 |
NPV = C1+C2+C3+C4 |
|
Investment X |
Investment Y |
|||||||
|
Period |
Period |
|||||||
|
Particulars |
1 |
2 |
3 |
4 |
1 |
2 |
3 |
4 |
|
t1 |
t2 |
t3 |
t4 |
t1 |
t2 |
t3 |
t4 |
|
|
Cash Flows |
-40000 |
12000 |
18000 |
27000 |
-40000 |
18000 |
18000 |
18000 |
|
C1 |
C2 |
C3 |
C4 |
C1 |
C2 |
C3 |
C4 |
|
|
IRR |
17% |
16.6% |
It should be noted that IRR is mainly computed on the basis of discount rate, which is not given in the case study. However, it can also be ascertained from the undiscounted cash flows, though the outcomes are not reliable under this technique (Abor 2017).
Required rate of return is determined on the basis of return rates of similar investments. Cost of capital can also be used as the required rate of return. However, in this case study, no such information has been given in regards to return rate of similar investments or cost of capital. Hence, the investments cannot be compared depending on the required rate of return (Burns and Walker 2015).
|
Particulars |
Bond 1 |
Bond 2 |
|
|
Face Value |
A |
$100,000 |
$100,000 |
|
Coupon Rate p.a. |
B |
6% |
6% |
|
Nos. of Coupon Payment p.a. |
C |
2 |
2 |
|
Coupon Payment |
D=(AxB)/C |
$3,000 |
$3,000 |
|
Increase in Yield Rate |
E |
2% |
2% |
|
Current Yield Rate p.a. |
F=B+E |
8% |
8% |
|
Cuurent Half-Yearly Yield Rate |
G=F/C |
4% |
4% |
|
Settlement Date |
H |
2/15/2017 |
2/15/2017 |
|
Maturity Date |
I |
8/15/2020 |
8/15/2023 |
|
Balance Period |
J=(I-H) |
3.5 |
6.5 |
|
Nos. of Coupon Payments due |
K=(JxC)-1 |
6 |
12 |
|
Selling Price of Bonds |
L=Dx[1-{1/(1+G)^K}]/G+A/(1+G)^K |
$94,758 |
$90,615 |
The difference in the price movements of the two bonds has mainly occurred due to the difference in the maturity date of the two bonds.
|
Particulars |
Bond 1 |
Bond 2 |
|
|
Selling Price on 15 Feb,2017 |
A |
$94,758 |
$90,615 |
|
Coupon Payment |
B |
$3,000 |
$3,000 |
|
Days Since Last Coupon Payment |
C |
84 |
84 |
|
Total days between two Coupon Payments |
D |
184 |
184 |
|
Interest Due |
E=Bx(C/D) |
$1,370 |
$1,370 |
|
Selling Price on 7 Nov,2017 |
F=A+E |
$96,127 |
$91,984 |
|
Period |
|||||
|
Particulars |
0 |
1 |
2 |
3 |
4 |
|
Initial Investment: |
|||||
|
Cost of New Technology |
($600,000.00) |
||||
|
Compensation to Tenant |
($44,000.00) |
||||
|
Additional Current Assets |
($30,000.00) |
||||
|
Total Initial Investment |
($674,000.00) |
$0.00 |
$0.00 |
$0.00 |
$0.00 |
|
Operating Cash Flow: |
|||||
|
Reduction in Labor Cost |
$0 |
$200,000.00 |
$200,000.00 |
$200,000.00 |
$200,000.00 |
|
Depreciation on Technology |
$0.00 |
($150,000.00) |
($150,000.00) |
($150,000.00) |
($150,000.00) |
|
Loss on Rental Income |
$0.00 |
($40,000.00) |
($40,000.00) |
($40,000.00) |
($40,000.00) |
|
Ovehauling Cost |
$0.00 |
($20,000.00) |
|||
|
Net Incremental Profit/(Loss) before Tax |
$0.00 |
$10,000.00 |
($10,000.00) |
$10,000.00 |
$10,000.00 |
|
Less: Income Tax |
$0.00 |
$3,000.00 |
$0.00 |
$3,000.00 |
$3,000.00 |
|
Net Incremental Profit/(Loss) after Tax |
$0.00 |
$7,000.00 |
($10,000.00) |
$7,000.00 |
$7,000.00 |
|
Add: Depreciation on Technology |
$0.00 |
$150,000.00 |
$150,000.00 |
$150,000.00 |
$150,000.00 |
|
Net Operating Cash Flow |
$0.00 |
$157,000.00 |
$140,000.00 |
$157,000.00 |
$157,000.00 |
|
Terminal Value: |
|||||
|
Sale of Technology |
$30,000.00 |
||||
|
Less: Tax on Selling Price |
($9,000.00) |
||||
|
Net Sales Income from Technology |
$21,000.00 |
||||
|
Recovery of Current Assets |
$30,000.00 |
||||
|
Total Terminal Value |
$0.00 |
$0.00 |
$0.00 |
$0.00 |
$51,000.00 |
|
Net Annual Cash Flow |
($674,000.00) |
$157,000.00 |
$140,000.00 |
$157,000.00 |
$208,000.00 |
|
Cost of Capital |
10% |
10% |
10% |
10% |
10% |
|
Discounted Cash Flow |
($674,000.00) |
$142,727.27 |
$115,702.48 |
$117,956.42 |
$142,066.80 |
|
Net Present Value |
($155,547.03) |
As the NPV of the project is negative, it would be better to not to invest in the new technology.
Reference
Abor, J.Y., 2017. Evaluating Capital Investment Decisions: Capital Budgeting. In Entrepreneurial Finance for MSMEs (pp. 293-320). Springer International Publishing.
Burns, R. and Walker, J., 2015. Capital budgeting surveys: the future is now
Mukherjee, T.K. and Al Rahahleh, N.M., 2013. Capital budgeting techniques in practice: US survey evidence. Capital Budgeting Valuation: Financial Analysis for Today’s Investment Projects, pp.151-171
Robinson, C.J. and Burnett, J.R., 2016. Financial Management Practices: An Exploratory Study of Capital Budgeting Techniques in the Caribbean Region
Rossi, M., 2015. The use of capital budgeting techniques: an outlook from Italy. International Journal of Management Practice, 8(1), pp.43-56.
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