Documente Academic
Documente Profesional
Documente Cultură
WORLD
MAHAM IBRAHIM L1F11BBAM2024
AHSAN EJAZ
L1F11BBAM2164
SUBMITTED TO : PROF. EESHA TARIQ
SECTION : B
SUBJECT : FINANCIAL ANALYSIS
QUESTION 1
(A) Calculation of NPV of modernizing the existing paper mill:
If actual cash flows are used
Investment required for the modernization = $154,700,000
Required rate of return = 12%
Yearly cash flow after tax deduction = $40,634,680 (for 20 years)
Net present value = C0 + present value of all future cash flows of 20 years
NPV = 303,518,451.5 - 154,700,000
NPV = $148,818,451.5
(B) Calculation of NPV for building a new paper mill
Investment required for the modernization = $618,800,000
Required rate of return = 12%
Yearly cash flow after tax deduction = $107,728,000 ( for 20 years)
NPV = 804,668,222.8 - 618,800,000
NPV = $185,868,222.8
Casio calculator
a) Cash button
b) I% = 12%
c) Cash= D.editor x
X
1
-154700000
29,212,360
29,212,360
29,212,360
29,212,360
29,212,360
29,212,360
29,212,360
29,212,360
10
29,212,360
11
29,212,360
12
29,212,360
13
29,212,360
14
29,212,360
15
29,212,360
16
29,212,360
17
29,212,360
18
29,212,360
19
29,212,360
20
29,212,360
21
29,212,360
d) NPV = solve
e) NPV = $ 63,500,076.15
(B) Calculation of NPV for building a new paper mill
Investment required for the modernization = $618,800,000
Required rate of return = 12%
Yearly cash flow after tax deduction = $107,728,000 ( for 20 years)
Incremental cash flow =$107,728,000 - $ 11,422,320 = $ 96,305,680
Net present value = C0 + present value of all future cashflows of 20 years
Casio calculator
a) Cash button
b) I% = 12%
c) Cash= D.editor x
X
1
-618,800,000
96,305,680
96,305,680
96,305,680
96,305,680
96,305,680
96,305,680
96,305,680
96,305,680
10
96,305,680
11
96,305,680
12
96,305,680
13
96,305,680
14
96,305,680
15
96,305,680
16
96,305,680
17
96,305,680
18
96,305,680
19
96,305,680
20
96,305,680
21
96,305,680
d) NPV = solve
e) NPV = $ 100,549,850
This shows that NPV of new paper mill is higher than that of modernization of the existing
facility. Thus, using NPV rule demonstrates that new facility is better for the firm.
QUESTION 2:
With Incremental Cash flows
(A) Calculation of IRR of each investment
IRR of Modernization of existing mill :
Using the Casio calculator where the cash flows and the initial investment was entered we move
on to the
IRR = solve
IRR = 18.219%
IRR of new paper mill:
Using the Casio calculator where the cash flows and the initial investment was entered we move
on to the
IRR = solve
IRR = 14.531%
According to IRR rule the firm should invest in the modernization of the existing paper mill as it
has a higher IRR .
(B) Calculation of the payback period of each investment
Payback period of Modernization of existing mill :
Initial investment / annual cash flows
= $154,700,000/$40,634,680
= 3.807 years
Payback period of new paper mill:
Initial investment / annual cash flows
= $618,800,000/$107,728,000
= 5.744 years
According to payback rule the investment made in the modernization of existing paper mill will
be recovered earlier then the investment in the new paper mill.
QUESTION 3:
(A) NPV and IRR methods give the same accept / reject signals:
No, NPV and IRR methods do not give the same accept/ reject signals. NPV accepts the
investment in building a new paper mill while IRR method accepts the investment in the
modernization of the existing paper mill.
(B) NPV and IRR methods can give divergent signals when evaluating mutually
exclusive alternatives:
In mutually exclusive projects, all projects serve the same purpose and therefore such
projects cannot be undertaken simultaneously. In case of mutually exclusive projects only
one project can be accepted and the others are to be rejected. In case of such projects the
cash flows of one project can actually be adversely affected by the acceptance of the
other project.
The reason that NPV and IRR methods are giving different decisions for the projects, building of
new paper mill and modernization of existing paper mill are:
The investment scale is different for both the projects. Building a new paper mill requires
higher investment as compared to the other project.
The cash flows are also different of both the projects. The cash flow of building a new paper
mill is $67,093,320 more than the cash flow of the modernization of existing paper mill.
Thus, the magnitude of cash flows is also the reason of divergent signals.
QUESTION 4:
If the life of modernized paper mill becomes 15 years the payback period as calculated in
Question 2 part b would not change and would remain 3.807 years but the NPV if calculated
would change.
Investment required for the modernization = $154,700,000
Required rate of return = 12%
Yearly cash flow after tax deduction = $40,634,680 (for 15 years)
Net present value = C0 + present value of all future cash flows of 15 years
Casio calculator
a) Cash button
b) I% = 12%
c) Cash= D.editor x
X
1
-154700000
40634680
40634680
40634680
40634680
40634680
40634680
40634680
40634680
10
40634680
11
40634680
12
40634680
13
40634680
14
40634680
15
40634680
16
40634680
d)
e)
f)
g)
NPV = solve
NPV = $122,057,300
IRR = solve
IRR = 25.384%
-154700000
29,212,360
29,212,360
29,212,360
29,212,360
29,212,360
29,212,360
29,212,360
29,212,360
10
29,212,360
11
29,212,360
12
29,212,360
13
29,212,360
14
29,212,360
15
29,212,360
16
29,212,360
d)
e)
f)
g)
NPV= solve
NPV=$ 44,261,425.38
IRR= solve
IRR = 17.118%
The NPV decreases with the decrease in number of years but still remain positive. Similarly
there is a decrease in IRR with the change in number of years. The IRR has decreased round
about 1.1% as compared to previous IRR calculation with 20 years cash flows.
Thus, it shows the effect of latter cash flows on IRR and NPV is less and early cash flows have
greater effect on IRR and NPV. Therefore its a better option to choose modernization of existing
paper mill as it has a lower payback, positive NPV and higher IRR and the employees only have
to cover 15 miles to reach it.
According to the statement the yearly cash flows if multiplied by 5 give a large cash flow that
is actually affecting the NPV but in reality the effect is very little and 5 years can also be
omitted.
QUESTION 5:
Based on the calculations, modernization the existing facility would be better option because of
its early payback, higher IRR and positive NPV (although less than that of new facility). Based
on the information in the case, modernization the existing facility would be again better because
new facility location is 15 miles away from the existing facility which would increase the
employees' expense and this would be unfair with employees and it may decrease their loyalty
for company. So, we recommend to modernize the existing facility.
QUESTION 6:
(A)
Casio calculator
a) Cash button
b) I% = 12%
c) Cash= D.editor x
X
1
-464,100,000
67093320
67093320
67093320
67093320
67093320
67093320
67093320
67093320
10
67093320
11
67093320
12
67093320
13
67093320
14
67093320
15
67093320
16
67093320
17
67093320
18
67093320
19
67093320
20
67093320
21
67093320
d) IRR = solve
e) IRR = 13.258%
13.258% is the crossover rate of both the projects where there NPV = $126,379,470. If we
compare this rate to the required return 12% we will accept the project because the rate at which
the NPV of both the projects becomes equal is more than the required return.
Further if the cash flows have been overestimated this may be causing the result of IRR to be
13.248% that is only 1.25% more than required return may be the actual cash flows are lower
which may lower the IRR to 12% or even lower than that that can actually make the project
unacceptable.
(B)
If we explain the decision rule for IRR in case of mutually exclusive alternatives, we accept a
project which has IRR greater than its cost of capital, and If both the projects have IRR greater
than their cost of capital than we select the project having the highest IRR.
In mutually exclusive alternatives normally IRR and NPV give divergent signals which means if
IRR accepts a project, NPV rejects that project. Thus in this case NPV should be used as a
primary rule.
On the other hand if these projects would have been independent projects, IRR and NPV would
have given same answers. Normally in case of independent projects if NPV accepts the project
than IRR also gives the same decision. And In such projects we can accept all the projects if
there are no constraints.
QUESTION 7:
Data required for calculating the yearly cash flow
Modernization of existing
Initial Cost
($)
618,800,000
455
455
360 days
360 days
1200
2200
282.1
227.50
19,860,000
52,200,000
year
SL value
20 years
20 years
7,735,000
30,940,000
Tax rate
40%
40%
facility
Sales
(Price per ton x number of
($19,860,000)
($52,200,000)
($121,867,200)
($180,180,000)
EBT
$54,832,800
$ 127,980,000
($ 21,933,120)
($ 51,192,000)
Net income
$ 32,899,680
$ 76,788,000
Add Depreciation
$ 7,735,000
$ 30,940,000
$ 40,634,680
$ 107,728,000
QUESTION 8:
(A) Calculating operating cash flows
1st 5year cash flows would be:
Modernization the old mill
Building a new mill
Sales
$196,560,000
$360,360,000
Less: F.C.(dep not included)
(12,125,000)
(21,260,000)
Less: VC
(121,867,200)
(180,180,000)
Dep (SL5 years)=initial
(30,940,000)
(123,760,000)
investment/5
EBT
31,627,800
Less: tax
(12,651,120)
Free Cash Flow
18976680
Add: Dep
30940000
Net Cash Flow
49,916,680
Now, the net cash flows for rest of 15 years would be:
196560000
(12,125,000)
(121,867,200)
62567800
(25,027,120)
37,540,680
35,160,000
(14,064,000)
21096000
123760000
144,856,000
NPV
IRR
(B)
Q8 (b)
NPV (dep for 20 years)
NPV (dep for 5 years)
NPV change
NPV change %
170,320,703.2
29.98%
271,877,229.6
19.74%
-154700000
38,494,360
38,494,360
38,494,360
38,494,360
38,494,360
26,118,360
26,118,360
26,118,360
10
26,118,360
11
26,118,360
12
26,118,360
13
26,118,360
14
26,118,360
15
26,118,360
16
26,118,360
17
26,118,360
18
26,118,360
19
26,118,360
20
26,118,360
21
26,118,360
d)
e)
f)
g)
NPV = solve
NPV = $ 85,002,327.86
IRR= solve
IRR = 21.5224%
a) Cash button
b) I% = 12%
c) Cash= D.editor x
X
1
-618,800,000
133,433,680
133,433,680
133,433,680
133,433,680
133,433,680
83,929,680
83,929,680
83,929,680
10
83,929,680
11
83,929,680
12
83,929,680
13
83,929,680
14
83,929,680
15
83,929,680
16
83,929,680
17
83,929,680
18
83,929,680
19
83,929,680
20
83,929,680
21
83,929,680
d) NPV = solve
e) NPV = $ 186,558,850
f) IRR= solve
g) IRR = 17.4369%
Modernized mill
$ 63,500,076.15
New mill
$ 100,549,850
depreciation
NPV of project with 5 year
$ 85,002,327.86
$ 186,558,850
depreciation
IRR of project with 20 year
18.219%
14.531%
depreciation
IRR of project with 5 year
21.5224%
17.4369%
depreciation
Change in NPV
$ 21,502,251.71
$ 86,009,000
Change in IRR
3.3034%
2.9059%
NPV change in %
33.86%
85.54%
By using incremental cash flows also we get to know that the percentage change in NPV of new
mill project is higher.
The NPV change would be higher in building a new mill, possible reasons would be the
magnitude of early and latter cash flows. Latter cash flows experience greater impact of discount
rate rather early cash flows. 5 year depreciation makes early cash flows higher.
QUESTION 9:
For calculating the cash flow where the annual production is minimum which makes the project
unacceptable we calculate the payment through annuity formula:
PV= C x ((1-(1+r)-n)/r)
R= 12%
n= 20
Calculation of Cash Flow
Cash Flows
=$ 20711047.27
= $ 82844189.09
$ 20,711,047.27
($7,735,000)
12,976,047.27
$ 21,626,745.45
$ 19,860,000
$ 41,486,745.45
239,946.47455
$ 67,688,900.47
$ 82,844,189.09
($30,940,000)
51,904,189.09
$ 86,506,981.82
$ 52, 200,000
$ 138,706,981.8
609,701.019
$ 138,706,981.8
$ 109,175,645.9
$ 277,413,963.6
QUESTION 10:
(A)
No, it is not appropriate to judge different proposals on same discount rate because each proposal
has its own cost and cost of capital which is according to its risk. So, in order to evaluate the
proposals, we should compare proposal's own cost of capital with its IRR. If IRR is greater than
that of its cost of capital proposal should be accepted otherwise rejected.
(B)
Yes, it is possible that my decision would be change if both projects have different cost of
capital. Change in cost of capital can also change the decision we made on the basis of IRR in
question 5 of selecting the project of modernization of existing mill. If both projects would have
higher IRR than their discount rate than I would select project with higher NPV.