Managerial Financing

In project two new machinery a proposal is made to purchase new machinery. As per given data a research and calculation is made to calculate net cash flow after tax. NPV of project is analysed and also sensitivity analysis is made by changing its cost of capital rate from 14.65% to 15.5% and analysis of change in rate have been included likes its effect of change compared to actual output. And lastly all calculations are explained in brief whic help mangers of Polycorp Ltd. to accept project or not.

Task 1 Calculation of project 1

1.1 Loan repayment Schedule   

Amortisation schedule is a table which is detailed how to pay loan specially mortgage or in instalment payment system.  It refers to process which is repayment of debts along with interest. So in this chart a portion of payment is settled toward both remaining interest and capital amount to be paid. Over a period of time as instalment deposits interest on due amount decreases and capital balances.

1.2 NPV of the project

NPV is method used in capital budgeting in analysing a project's cash inflow and cash outflow. Profitability of project or investment of project is calculated in NPV(Ruan, D. and Tolga, E., 2002). Using NPV formulae if a project gives positive result more then the invested project then the project is accepted. Or in simple term the project having positive value will give a profit in project while value with negative will give a loss in a project(Flanagan, J., 2015).

1.3 IRR of the project

It is alternative tool of NPV where calculation follows same formulae with slight change. It sis calculated in neutral NPV or present value of project is zero and rate of return is discounted at present value and whole projects present value become zero. It is also used as measuring  profitability of current project same like NPV by putting NPV is at zero and discounted at rate of return(Thompson, B., 2015). The higher the IRR the the more profitable the project. If IRR is negative it shoul be rejected.

1.4 AE annual equivalent of the Project

 Equivalent annuity cash flow is method used in capital budgeting to compare two project's profitability of future value. The equivalent annual annuity approach calculates the constant annual cash flow generated by projects over life period of project if it was annuity. When used to compare project with unequal lives. The project having higher EAA should be selected.

Formulae of EAA is c = (r*NPV)/(1-(1+r)^-n)

where c= equivalent annual cash flow,

NPV= Net present Value

r= interest rate per period

n= number of periods

c= (.1205*-1544027.28)/1-(1+0.1205)^-5

  = -428858.8

1.5 PB, the payback and discounted payback in years

payback period is period or time required to recover cost of capital. Payback period of given project is calculated and efforts are tried to keep these period as short as possible. So in general term the longer Payback period the project is rejected and shorter payback period the project is accepted. The main important point to consider in it is it ignores time value of money unlike, other method of capital budgeting method. Like NPV, IRR, Discounted cash flow.

 

Discounted Payback: It is also used to determine profitability of project. A discounted pay back is method to discount future cash flow and recognising time value of money.  For calculation a project is accepted if the discounted payback period is less then targeted period. If result is more then it is rejected.

1.6 ARR of the project: Accounting or Average rate of return is financial ratio or percentage used in capital budgeting. It does not consider time value of  money which means where a present value of money is more then the future value of money. It is calculated as average of total of net cash flow and divided by Initial investment. So A project will give average return as percentage at the end of each year.

 

1.7 Present Value index or profitability index

Profitability index also known as Profit or value investment ratio. It is important tool can be used to give a ranking of the project because it allow to create a per unit value of investment going to be made in project. cash flow calculated does not included the initial investment of the project. So any lower value of the project then it is assumed that present value of project is less then future value of project. And if higher the value the present value is more then future value.

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range of Profitability is

• If PI>1 then project is accepted.

Profitability index is present value of future cash flow/ initial investment so

 PI= 1705972.71/3250000 = 0.524914681

1.8 Brief explanation

As per given data analysis and calculation of various tools such as repayment or amortisation schedule,NPV, IRR, Annual Equivalent of  Project, PB ratio and discounted pay back, Present Index, the project should be rejected because:

NPV: After calculating net cash flow and discounted cash flow at 12.05% the NPV of project after subtracting from initial investment is -1544027.28. So as per figure it is rejected.

IRR: After calculating Net cash flow and calculating with initial investment it is -8.31%. So  to accept irr should be positive and more then interest rate so it is rejected.

AE of project: Higher the Equivalent Annuity cash flow the project is profitable so it must be higher and positive to accepted as compare to another, So here it is -428858.87. So it is rejected.

Payback and discounted payback Period: As per its calculation

In payback all five years It is continuous negative and lastly in 5th yr it is -817012.

In discounted pay back: Same tend in figure found with negative and for fifth yr it is -1544027 hence it is not acceptable or rejected.

ARR: In ARR the result after calculation is 14.97% so as above figure is negativeit is rejected.

PI or present value index: In PI the value of project is  0.524914681 which is less then one so it is rejected. If value is more then one then it is accepted.

TASK 2

2.1 Net cash flow after Tax

Net cash flow after tax(CFAT) is a measuring tool that measure the financial performance that look at companies ability to generate cash flow through it various operations and process. It is calculated as adding like amortisation+ depreciation + net income+ other non cash- cash charges. It is measured to know whether company have ability to generate cash flow in given investment or it require additional capital to growth or expansion of business or business project(King, R.G. and Levine, R., 1995).

2.2 Calculation of NPV and decision

It is measurement of performance of particular business project and profitability tools used in capital budgeting (Gitman, L.J. and Zutter, C.J., 2012). In it cash flow is discounted on rate of cost of capital and then multiplied by discounted flow and totalled DF is subtracted by initial investment then NPV is generated. If value is positive then accepted and if value is negative then rejected.

As per above data NPV is positive and 4839777 which is more as compared to initial investment hence it is accepted because it will definitely give positive growth in future. IRR is also positive and  is 25.72 hence it is accepted.

2.3 Sensitivity analysis:

Sensitivity analysis of project is if change in certain figure how much change in result output or obtained result is how much contract or deviate of given project. So here we have changed cash flow cost of capital from 14.65% to 15.5% so as per result Net present value decreased from  4839777 to 4800927 that means 39750 value decreased. This means if we increase more cost of capital then NPV will more likely to decrease. As discounted factor will increase. So to gain more return from project the minimise cost of capital as low as possible.

2.4 Short report explaining calculation of relevant net cash flows after tax, justifying selection of cash flows

Net cash flow is calculated on the basis of Beginning investment+ initial working capital+ pilot market study and other cash inflow from sales are included. For cash outflow cash operating expenses is calculated by total sales*0.8 given selling expenses and adding marketing+ head office cost+ depreciation= total expenses. Then profitability is found by total sales- total expenses. Taxation is calculated by profit*28% tax. Net profit after sales is profitability - tax. and depreciation is added and allowance @ 25% is added. So in 3rd yr resale value and value of working capital is added and finally Net cash flow is found(Bushuyev, S.D., 2015). Net cash flow is in positive trend over a period of three year and project is accepted. Investment allowance given @ 25%  assumed for all the three year and have been calculated as per case study.

Summary

This project is managerial financing based and it this project two projects one with loan regarding and feasibility and other with purchase of machinery related have discussed. In first project the amortisation value of loan is calculated. After it NPV, IRR, AE, PB method or discounted PB, ARR or accounting rate of return, Profitability index etc. have been included. So as per calculation the project is rejected and It is not profitable investment for business.

In second projects Net cash flow after Tax and its NPV and sensitivity analysis is made and after result obtained the project is acceptable and have future return tendency and growth.

References

• Osborne, M.J., 2010. A resolution to the NPV–IRR debate?.The Quarterly Review of Economics and Finance,50(2), pp.234-239.
• Kahraman, C., Ruan, D. and Tolga, E., 2002. Capital budgeting techniques using discounted fuzzy versus probabilistic cash flows. Information Sciences,142(1), pp.57-76.
• Gitman, L.J., Juchau, R. and Flanagan, J., 2015.Principles of managerial finance. Pearson Higher Education AU.
• King, R.G. and Levine, R., 1995. Finance and growth: Schumpeter might be right. The quarterly journal of economics108(3). pp.717-737
• Musgrave, R.A. and Musgrave, P.B., 1973. Public finance in theory and practice.