HI5002 Finance for Business

Group Assignment
Trimester 2, 2016

Part A

1. What is the payback period of the project?

The payback period is one of the methods to analyze the project in terms of amount invested that
can be repaid in future in the shape of net cash outflows by the assets. It is effective method to
evaluate the risk analysis of the project investment and it provides the rapid information about
time that is required to recover the initial investment and risk.
Year
0
1
2
3
4

Annual Cash flows

(34,500,000)
17,206,000
13,482,000
11,718,000
7,014,000

Cumulative NPV
(34,500,000)
(17,294,000)
(3,812,000)
7,906,000
892,000

Payback period = 2 + (3,812,000 / 11,718,000)

Payback period = 2.33
According to the above analysis which is indicating that this project will require almost 2.33
years to recover its initial amount of investment. Therefore, we can say that this project is
feasible and will be beneficial for the companys shareholders.

2. What is the profitability index of the project?

Profitability index is also known as profitability ratio which is used to evaluate the payoff of
project investment. It is efficient analysis in terms of ranking the different project based on most
profitability that measure the value created by per unit of project investment.
Profitability index = 1 + Net present value (NPV) / Initial Investment
Profitability index = 1 + 3,107,574 / 34,500,000
Profitability index = 1.09
According to the above analysis, project is valuable because the profitability index showing the
positive results i.e. 1.09. Therefore, we can say that this project is reasonable to advantage the
company in the market.

3. What is the IRR of the project?

It is one of another project appraisal method that ranking the project on the basis of percentage
by discounting the future expected cash flows. The IRR is also the rate where NPV is equal to
zero. It is rate of return that equates the future expected cash inflows with initial value of project
cost. The formula of the IRR is mentioned below.

The IRR (internal rate of return) is showing the results in percentage term. Under the acceptance
or rejection of the project through IRR method, the proper discount rate is that used that should
be more than cost of capital in order to accept the project. Higher the IRR rate increase the value
of shareholders and easy approach to understand the project acceptance decision making
(Freeman, 2013).
During the calculation of IRR, the cost of capital of the project is also the estimate that creates
the margin in between minimum required rate of return and internal rate of return which may be
less accuracy and small that cannot be useful for project acceptance. One of another limitation of
IRR, that may be multiple IRR or no IRR when non-conventional cash flows are attached with
project (Bhoora, 2001).
The IRR (internal rate of return) is the rate that presents the present value of project investment
where in-flow and outflow of money are equal and NPV is zero. It is also include the major
concept of time value of money (TVM) by using of discount rate factor. It is very useful
techniques mostly implemented in industries of European countries.
Internal Rate of Return (IRR)

Advantages

There are following advantages of IRR

o It is one of the method that includes the concept of TVM (time value of money),
which is most important part of project appraisal.
o It is based on cash flow instead of accounting profit.
o It is also includes the whole projects life projections.
o The corporate firms can easily evaluate the project acceptance decision making rule,
if the IRR is more than minimum cost of capital or not. If IRR more than cost of

capital than accept the project otherwise reject it.

Limitations

The IRR has major limitation as mentioned below

o The IRR is showing the results in terms of percentage which some time difficult to
understand and compare the results with different project such as size, return /
outcome.
o Difficult to accept the project when mutually exclusive projects are in place, their
level of risk is not completely accounted. Lack of recognizing proper risk level
associated with project selection decision making.
o It is very difficult to calculate the absolute profitability with IRR.
o It is sometime complex to calculate.
o There may be more than one IRR or multiple IRR.

Cash flows
17,206,0
00
13,482,0
00
11,718,0
00
7,014,0
00

Discount at 12%

NPV @ 12%

PV @ 12%

Discount at
17%

PV @ 17%

0.89 15,362,500

0.85 14,705,982.91

0.80 10,747,768

0.73 9,848,783.69

0.71 8,340,641

0.62 7,316,374.18

0.64 4,457,524
0.53 3,743,021.44
3,107,574 NPV @ 17%
(186,696)

A= Lower rate of discount

12%
B= Higher rate of discount
17%
a = NPV of lower rate of discount
3,107,574
b = NPV of higher rate of discount
(186,696)
IRR
12.24%
According to the IRR (internal rate of return) analysis, it is indicating that this project will be
stand at IRR 12.24% which is higher than cost of capital. As we know that higher the IRR will

shows the acceptance of the project and lower IRR project will not be accepted. Therefore, we
can accept the project due to IRR more than cost of capital.
4. What is the NPV of the project?
The NPV is one of the capital appraisal methods that provide the vital information for investment
project. With the using of NPV method that corporate discount back the future cash flows and
outflows on the basis of discount rate or marginal cost of the capital project. The equation of the
NPV is mentioned below

As per the above equation of NPV, the CFt is indicates that expected future cash flows, t (number
of period), k (cost of capital), n (number of period of the project life). When the project NPV
value is zero or more then it represent that project is enough to create the positive value of the
shareholders, which means NPV is positive. On the other side if the NPV value is less than zero
or negative then project is not enough to increase the shareholders value. Higher the positive
NPV value or more than minimum required rate of return increase the profitability and growth
level of the potential shareholders (Freeman, 2013).
Depreciation of new equipment
Initial cost of equipment
salvage value
Useful life
Depreciation rate
Depreciable asset cost
Annual depreciation
Quantity
Year 1
Year 2
Year 3
Year 4
Total revenue

Units
106,000
87,000
78,000
54,000

Price rate
485
485
485
485

34,500,000
5,500,000
4
0.25
29,000,000
7,250,000
Total Revenue
51,410,000
42,195,000
37,830,000
26,190,000
157,625,000

Quantity
Year 1
Year 2
Year 3
Year 4

Units

Variable cost
205

106,000

205

87,000

205

78,000

205

54,000

Total cost

Total cost
21,730,000
17,835,000
15,990,000
11,070,000
66,625,000

Year 1

Year 2

Year 3

Year 4

Sales

51,410,000

42,195,000

37,830,000

26,190,000

Variable expenses

21,730,000

17,835,000

15,990,000

11,070,000

Contribution margin

29,680,000

24,360,000

21,840,000

15,120,000

Fixed cost

5,100,000

5,100,000

5,100,000

5,100,000

Cash flow before tax

24,580,000

19,260,000

16,740,000

10,020,000

Taxable income

24,580,000

19,260,000

16,740,000

10,020,000

Income tax @ 30%

7,374,000

5,778,000

5,022,000

3,006,000

Cash flow after tax

17,206,000

13,482,000

11,718,000

7,014,000

Cash flows

Discount
at 12%

Present value (PV)

of cash flows

Initial cash flow

(34,500,000)
17,206,000
13,482,000
11,718,000
7,014,000

Working capital needed

Salvage value of

0.89
0.80
0.71
0.64

15,362,500
10,747,768
8,340,641
4,457,524
(10,282,000)
2,446,745

equipment
Release of working capital
Total Present value of cash
flows

6,534,397
38,908,433
Net Present value
(NPV)

3,107,574

The NPV (net present value) method of project appraisal is discounting back the future expected
cash flows in term of present value that are linked with project. The difference between the
negative value of initial cash outlay and positive future expected cash inflow is the sum NPV.
Higher the positive future cash flow means the project is more feasible that ultimately enhance
the value of shareholders.
The analysis is indicating that this project has positive NPV 3,107,574. Therefore, we can say
that this project will provide the benefit to the company in terms of more cash inflows and
increase the future growth of the company.
5. How sensitive is the NPV to changes in the price of the new smart phone?
Current NPV = 3,107,574
If price change (increase) from 485 to 495 = 4,672,423
Sensitivity analysis = NPV / Price
(4,672,423 3,107,574) / (495 485)
Sensitivity analysis = 156,484.90
The analysis is indicating that if we increase the price of mobile phone, then it will increase the
profit and if we decrease the price of mobile phone then it will decrease the profit of the
company. Therefore, we can say that higher the price increase the project return in terms of more
cash inflows.

6. How sensitive is the NPV to changes in the quantity sold?

NPV is more sensitive to the changes in the quantity sold, as per analysis of change in price will
affect the NPV. Therefore, we can say that more sold of quantity will increase the NPV and lower
NPV will decrease the NPV of new mobile phone project.

7. Should Emu Electronics produce the new smart phone?

The decision rule of acceptance or not acceptance of the project is described as per mentioned
below
o Positive NPV value then project are more financial sound and accept it.
o The breakeven point of NPV is zero and still decision making towards acceptance.
o If the project NPV value is negative then not accept the project as it value is less the
minimum required rate of return.
o During the course of mutually exclusive project, accept the project with the higher
positive NPV value than lower.
The NPV (net present value) project appraisal method is one of the superior than others as per
the following respects of understanding
o It is includes the main type of TVM (Time Value Money) concept which is most
important part of any project evaluation process.
o It calculates the future expected cash flows instead of accounting profit.
o It is measure the project return on absolute value.
o It includes the whole project life value of cash flows
o It is maximum provides the opportunity to evaluate the project financial feasibility on
lead basis which ultimately showing the future shareholder wealth.

Disadvantages
o It is sometimes complex to describe the various parts to shareholders and other
management.
o More understanding required of minimum required rate of return or cost of capital in
order to evaluate the true value of future expected cash flows.
o It is very complex to evaluate the project value.
o It is required higher weight of WACC (Weighted Average Cost of Capital) for upward
sloping project risk and lowers for downward sloping project risk.

The evaluation or appraisal techniques of discounting cash flows such as NPV and IRR both
have significant importance for organization to make wider decision making process. Both
techniques have several limitations and advantages according to the nature of evaluation of
project. The empirical analysis about IRR indicates that it is provides the results in terms of
percentage that can be easily understand by higher executive members. If the IRR provides the
positive percentage with more than minimum required rate of return / cost of capital then accept
the project otherwise reject it. The IRR may have multiple IRR or no IRR during nonconventional cash flows, which create the difficult for making decision regarding acceptance or
not. The NPV is one of the appraisal methods that eliminate the IRR complications through
providing the most reliable strategic based evaluation about project decision making. If the future
expected cash flow are more than initial cash outlay then accept the project otherwise reject it.
The NPV is also mostly preferred method for strategic capital appraisal decision making as it
includes the wide range of information in terms of cash flow, time value of money, uncertainty
with project and other relevant information that enhance the project evaluation process. Most of
the multinational companies are both using the IRR and NPV methods during the course of
project evaluation. The management is advice to critically understand their merits and demerits
in order to make decision making more efficiently and effectively. However, corporate managers
are required to critically evaluate the both projects appraisal methods and make sure the hurdle
level (cost of capital) must be achieved for making acceptance decision. NPV is most dominating

appraisal method than IRR as it is includes the wide decision making and evaluation concept for
strategic business decision making.
According to the above decision rules of NPV, it is indicating that Emu Electronics must accept
the project as the new smart phone NPV is predicting the positive future cash inflows more than
cost of capital. Therefore, this should be accepted.
8. Suppose Emu Electronics loses sales on other models because of the introduction of
the new model. How would this affect your analysis?
Cannibalization has two direction either positive or negative effect on the sale performance of
the company during the course of introduction new product in the market. It is the situation when
new product will reduce the demand or sales of an existing product which can be negatively
effect on overall demand of existing product in the market. This can be called negative affect of
both market share and demand / volume of sale of the existing product.
If the new mobile phone will have no effect on existing products then it will be positive
cannibalization and if there is negative effect on existing products then it will be negative
cannibalization effect on the company performance. Therefore, it is very important to conduct
study before launching of this new model of mobile phone in order to secure the existing
products of the company.

Part B
Question1:
Following data and information is showing the book value of debt and equity of Harvey Norman.
The data was collected from the financial statement for the period ended 30th June, 2016.
Book value of debt =

269,459,105

Book value of equity = 2,537,000,000

Total = 2,806,459,105
Weightage of debt and equity values
Weighted of debt:
Wd =

269,459,105 / 2,806,459,105

Wd = 9.60%
Weighted of equity:
We = 2,537,000,000 / 2,806,459,105
We = 90.40%
The analysis is indicating that Harvey Norman has more weightage in equity by 90.40% and debt
by 9.60%.
Question 2:
Following calculation is showing the several things such as stock price, market value of equity /
market capitalization, shares outstanding, annual dividend, beta, government yield or risk free
rate of return and market rate of return.
What is the most recent stock price listed for Harvey
Norman?
What is the market value of equity, or market capitalization?
How many shares does Harvey Norman have outstanding?
What is the most recent annual dividend?
What is the beta for Harvey Norman?
What is the yield on government debt? RFR
Market rate of return

5.20 AUD
5.75 B
1,112.56 Million
0.17
0.74
2.37%
5.5%

The capital asset pricing model (CAPM) offers us to compute and measure investment risk and
investment return. A model that depicts the relationship in the risk and expected return and that is
utilized as a part of the evaluating of risky financial securities. The general thought behind
CAPM is that speculators should be repaid in two ways: time value of money and risk. The time
value of money is spoken to by the risk free (rf) rate in the equation and repays the financial
specialists for putting funds in any venture over a timeframe (Sharfzadeh, 2006).
A portfolio built to have zero systematic risk or, at the end of the day, a beta of zero. A zero-beta
portfolio would have the same expected return as the risk free rate. Such a portfolio would have
zero connection with market movements, given that its expected return levels with the risk free
rate, a low rate of return (Vendrame, 2014).

CAPM

CAPM
(Ke)

Cost of equity = Risk free rate of return + Beta (market rate of return risk free rate of
return)
RFR
Beta
Market rate of return
Market risk premium
Beta (market rate of return risk free rate of return)
Risk free rate of return + Beta (market rate of return Risk free rate of return)

2.37%
0.74
5.5%
3.13%
0.023
4.7%

According to the analysis, CAPM or cost of equity of Harvey Norman is 4.7%.

Question 3
The cost of debt is an amount of component of WACC (weighted average cost of capital) which
can also called as rate of interest to be paid against debt shares issuance in the market.
Cost of debt
Rd = Rate of debt issued
tc = tax rate
1-tax rate
Cost of debt
The cost of the debt of Harvey Norman is 8.33%.

Kd (1-tc)
11.90%
30%
0.7
8.33%

Question 4
The weighted average cost of capital (WACC) is the minimum rate of return on capital required
to compensate debt and equity investors for bearing risk
WACC = Weighted cost of equity x Cost of equity + Weighted cost of debt x Cost of debt
Such focus on value creation has served the shareholders of Harvey Norman. A Harvey Norman
invested capital multiplied by WACC gives the minimum level of operating profits should
generate to satisfy shareholders.
WACC
We
Ke
Wd
Kd
WACC

90.40%
4.7%
9.60%
8.68%
5.07%

The cost of capital or WACC (weighted average cost of capital) is 5.07%. Harvey Normans
management is required to at least or higher than WACC must generate the operating profit in
order to increase the efficiency of business operations as well as keep paying their liabilities in
future more effectively and efficiently.
Question 5
Pure play method
A = Hubbard Computer Ltd (HCL)
B = Harvey Norman
Unlevered beta of B = (Equity) Beta Coefficient of B/ 1 + DEB (1 Tax RateB)
Unlevered beta
D/E ratio
Tax rate

0.74
0.11
30%

Unlevered beta of B = (Equity) Beta Coefficient of B/ 1 + DEB (1 Tax RateB) = 0.11 (1-0.3)
Unlevered beta of B = (Equity) Beta Coefficient of B/ 1 + DEB (1 Tax RateB) = 0.69

(Equity) Beta A = Unlevered Beta of B (1 + DEA (1 Tax RateA))

Unlevered beta of B
D/E ratio
Tax rate
HCL
Debt
Equity
D/E

0.69
0.027
30%

117.1
4302.7
0.027

(Equity) Beta A = Unlevered Beta of B (1 + DEA (1 Tax RateA)) = 0.027 (1-0.3)

(Equity) Beta A = Unlevered Beta of B (1 + DEA (1 Tax RateA)) = 0.70

References
Bhoora, G.D. (2001) An evaluation of the capital budgeting process for a multinational firm,
durban: unversity ofnatal.
Freeman, D.M. (2013) Which financial evaluation technique, NPV or IRR, is better to use when
selecting the best project among a number of mutually exclusive projects, and why?, Key Logic.
Freeman, D.M. (2013) Which financial evaluation technique, NPV or IRR, is better to use when
selecting the best project among a number of mutually exclusive projects, and why?, Key Logic.
Sharfzadeh, M. (2006) An empirical and theoratical analysis of Capital Asset Pricing Model,
Boca Raton.
Vendrame, V. (2014) Some Extensions of the Conditional CAPM , University of the West of
England.