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Fi 498 Cases in Finance

Essay by   •  January 31, 2018  •  Coursework  •  3,153 Words (13 Pages)  •  1,097 Views

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Fort Greenwold

Briana Thorn

FI 498 Cases in Finance

Data Analysis

We are trying to determine which project to undertake. Modernize the existing paper mill plant, or build a new facility in Midtown. To evaluate each project, we must first calculate the NPV (Net Present Value) and the IRR (Internal Rate of Return). We will also need to calculate the payback period for both projects.

The NPV for modernizing the existing paper mill

C0= -154,700,000

Cash Flow= 40,634,680

Frequency=20

NPV=$148,818,451.5

NPV for building a new paper mill

C0=618,800,000

Cash flow= 107,728,000

Frequency=20

NPV = $185,868,222.8

IRR for modernizing the existing paper mill:

IRR= 26.0089

IRR for the New Facility:

IRR = 16.6026

The payback period determines how long it will take to pay back the initial investment that has been undertaken for the project start. I have listed my calculations on the payback periods for each project.

Old plant Modernization

Years                                Cash Flow                        Cumulative cash flow

0                                -154,700,000                                -154,700,000

1                                40,634,680                                -114,065,320

2                                40,634,680                                -73,430,640        3 + ? months

3                                40,634,680                                -32,795,960

4                                40,634,680                                7,838,720

To find out how far into the 3rd year we will be paying, you must divide the last cumulative cash flow into the normal cash flow:

32,795,960/40,634,680 = .8070 or .81 months.

This leaves us with a payback period of 3.81 years for the old plant modernization.

New facility:

Years                                Cash Flow                        Cumulative cash flow

0                                -618,800,000                                -618,800,000

1                                107,728,000                                -511,072,000

2                                107,728,000                                -403,344,000

3                                107,728,000                                -295,616,000

4                                107,728,000                                -187,888,000

5                                107,728,000                                -80,160,000        5 + ? months        

6                                107,728,000                                27,568,000

To calculate how many months are left to pay, we must divide the last cumulative cash flow into the normal cash flow.

80,160,000/107,728,000 = .7440 or .74 months

This leaves us with a payback period of 5.74 years for the new facility.

When looking at the NPV and IRR you want to take the number with the higher number. In this case, the project in which you would have a higher NPV is building the new paper mill and the project in which you have a higher IRR is the project in which you would modernize the existing paper mill. This means that they do not give the same accept/reject signals.

There are a couple of different reasons you could have divergent signals. One could be that you have a difference in the investment scale. Another reason is that you have a difference in the cash flow magnitude and timing.

If we do a 15-year annuity for the modernization the existing facility, its payback would not really be affected much. Its IRR would decrease by roughly 1% and the NPV would decrease to 122,057,299.1 but would remain positive. It does not matter whether the projects would be for 15 years or 20, because cash flows have little impact in the end for both.

After looking at the calculations for both options, modernizing the existing facility would be better option at this point because of its earlier payback, positive NPV, and higher IRR. When looking at the information included the case, modernizing the existing facility would provide a better outlook for the current employees because new facility location is 15 miles away from the existing facility and that would increase the employees' expense, and this would be unfair to the employees and it could very likely decrease their loyalty for company. Based on this information, I think modernizing the existing facility is the best option at this point. I will be doing further analysis to ensure this is the right recommendation for the company.

Cost of Each Option

Building the new mill will require $464.1 million more than modernizing the old mill but will generate $67,093,320 extra in yearly cash flows. The IRR for this incremental expenditure is calculated as follows:

C0 = -$464,100,000

C1 = 67,093,320

F1 = 20

I = 12%

NPV = $37,049,771.31

IRR = 13.2580

If the IRR is of the additional investment is larger than the cost of capital, you can accept this project. Since the cost of capital is 12% and the additional investment produces a 13.26%, it is still plausible to accept.

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