Tag: NPV

Identify and describe a long-term investment project (either real or fictional) that would likely require significant capital commitment.Regardless of these factors, why might this project still be a worthy investment? Are there certain industries that might demand a more long-term strategy? Which ones? In your responses to your peers, compare and contrast your views with your classmates’ observations.

Discussion 2-1 FIN 660

Why might companies disregard a positive NPV? MIT professor of financial economics Stewart C. Myers asserts that different decision rules might apply when investments are long-term rather than short-term (Myers, 1977). Financial managers may rationalize that it is in their immediate interest to invest in short-term projects because they bring the most shareholder benefits; this is, in other words, the so-called agency problem. However, what could be the long-term consequences of that strategy? Watch the short agency problem video (7:14) below for an explanation of this conundrum in detail with good examples.

Identify and describe a long-term investment project (either real or fictional) that would likely require significant capital commitment.

If you were acting as a financial analyst, what factors would you consider in the decision to move forward or abandon the project? In your initial response, you may discuss such factors as:

NPV
IRR
EBIT
WACC
Corporate structure
Market structure
Corporate goals and mission

Regardless of these factors, why might this project still be a worthy investment? Are there certain industries that might demand a more long-term strategy? Which ones? In your responses to your peers, compare and contrast your views with your classmates’ observations.

The current corporate tax rate in the U.S. is 21%. There are tax increases in the works for 2021. The Biden administration proposed to raise the corporate tax rate from 21% to 28%. If the proposal is approved, how does that affect the WACC and the NPV?

Calculation of net present value and writing

Name two assumptions you implicitly make when you apply the WACC method to evaluate the project for your company. Recall the WACC method can only produce creditable results when certain assumptions hold. (You can find hints from Lecture Note 11.) Discuss whether these two assumptions are likely to hold for the project you choose.
The choice of risk‐free rate. We used the 5‐year U.S. Treasury yield as our risk‐free rate. Explain why this choice is reasonable or not.

You can find hints from the PPT ‐ Implementing CAPM of Lecture 10.
Cost of debt estimation. For a company without credit ratings, two methods are introduced to estimate its cost of debt (see the instruction 2.a.i above)

Use the debt beta of 0.31, the debt beta for CCC rated firms in Table 12.3, and apply the CAPM to estimate its cost of debt.

Use the weighted average of interest rates for its bank loans as a proxy for its cost of debt.

If the company does have a credit quality lower than the CCC rated firms, does your estimate based on method 1 overestimate or underestimate your company’s true cost of debt? Does your estimate based on method 2 overestimate or underestimate your company’s true cost of debt? Explain why? Recall that the cost of debt is the expected return required a firm’s creditors.

Cost of debt estimation. For a company that has bonds outstanding, based on its coupon payments, remaining maturity, and current price, we can estimate its yield to maturity (YTM). Does the YTM overestimate or underestimate your company’s true cost of debt? You can find hints from Lecture Note 4.

Equity beta.Is your company’s equity beta larger than 1 or smaller than 1? What does it tell you? Give your intuitive explanations. You can find hints from Lecture Note 9 ‐ Risk and Return ‐ Part II and the slides 6 and 7 in Lecture Note 10.

The current corporate tax rate in the U.S. is 21%. There are tax increases in the works for 2021. The Biden administration proposed to raise the corporate tax rate from 21% to 28%. If the proposal is approved, how does that affect the WACC and the NPV?

Comment on the importance of investment appraisal and explain the advantages and disadvantages for each of the following investment appraisal techniques

Corporate Finance

Calculate the Net Present Value (NPV) for each project
a) State the NPV decision rule
b) Based on the NPV decision rule, select the projects that should be financed with the £1,320,000 budget
c) Calculate the overall NPV for the selected projects in part b)
(Total: 25 marks)

2) Calculate the Profitability Index (PI) for each project
a) Use the calculation in part 2) to rank the projects from the most preferred to the least preferred
b) Explain the PI decision rule
c) Based on the PI decision rule select which of the projects should be financed with the £1,320,000 budget
d) Calculate the overall NPV for the selected projects in part c)

(Total: 25 marks)

3) Calculate the Internal rate of return of (i) Project 1, which has an initial cost of £800,000 and an annual cash inflow of £117,200 for 20 years; and (ii) Project 2, which has an initial cost of £200,000 and an annual cash inflow of £48,000 for 8 years. All the cashflows are in annuity.

Given that AZAR plc. operates a 14% minimum required rate of return policy, based on your IRR analysis, advice on which of the projects should be accepted or rejected.

(Total: 25 marks)

4) Comment on the importance of investment appraisal and explain the advantages and disadvantages for each of the following investment appraisal techniques
I. Net Present Value
II. Internal rate of return
III. Profitability index
IV. Modified internal rate of return

Explain, in your own words, why working capital investments are subtracted each year in the cash flows

Determine the NPV for the Electrobicycle project

Determine the NPV for the Electrobicycle project. Use the annual project cash flow from the table above. For the required rate of return, use the percent value from your birthday date. For example, if your birthday falls on the 16th of the month, the required rate of return would be 16%.

For guidance, review Section 7.1 of the textbook, NPV Example: The Pizza Scooter Delivery Project Revisited.

Calculate the NPV of the Electrobicycle project. Be sure to show your NPV calculations.

Explain, in your own words, why working capital investments are subtracted each year in the cash flows.

Explain, in your own words, the meaning of the required rate of return for the project.

Assume the auto company has a required rate of return of 15%. Based on the required rate of return you used for the Electrobicycles (based on your birthday date), is the Electrobicycle project more or less risky than the auto company? Explain your answer.

Based on your concluded NPV, should the company invest in this project to build Electrobicycles? Justify your answer.