This document discusses the key considerations in analyzing an investment project's cash flows and profitability. It addresses how to handle various costs like rehabilitation costs, interest expenses, and opportunity costs. It also discusses how the analysis would differ for replacement projects versus expansion projects. The document considers the impact of inflation on cash flows and indicators like NPV, IRR, payback period. It analyzes several example projects and recommends the most profitable one based on these metrics. Inflation is found to potentially improve or worsen a project's viability depending on how costs and prices are impacted.
This document discusses the key considerations in analyzing an investment project's cash flows and profitability. It addresses how to handle various costs like rehabilitation costs, interest expenses, and opportunity costs. It also discusses how the analysis would differ for replacement projects versus expansion projects. The document considers the impact of inflation on cash flows and indicators like NPV, IRR, payback period. It analyzes several example projects and recommends the most profitable one based on these metrics. Inflation is found to potentially improve or worsen a project's viability depending on how costs and prices are impacted.
This document discusses the key considerations in analyzing an investment project's cash flows and profitability. It addresses how to handle various costs like rehabilitation costs, interest expenses, and opportunity costs. It also discusses how the analysis would differ for replacement projects versus expansion projects. The document considers the impact of inflation on cash flows and indicators like NPV, IRR, payback period. It analyzes several example projects and recommends the most profitable one based on these metrics. Inflation is found to potentially improve or worsen a project's viability depending on how costs and prices are impacted.
Submitted to: Ms. Balcos Fin 105 Submitted by: Rea Mae Caracena Aimee Flordeliza Christopher unsalan Sarah !. Ro"as 1. #ncremental cash $o%s is de&ned as the additional cash $o% brou'ht about by a pro(ect. More speci&cally it is the cash $o%s attributable to the pro(ect itsel). #nterest e"penses are not included in the cash $o% statement* because i) it %as* then the cost o) debt %ould be double counted. !his is because the discountin' process already reduces the cash $o%s to account )or the pro(ect+s capital cost. #) interest e"pense %as also subtracted )rom the cash $o%* then the cost o) debt %ould be double counted. ,. !he -.00*000 that %as spent to rehabilitate the plant should not be included in the analysis because it is already a sun/ cost that can no lon'er be reco0ered. 1e are only interested in incremental CF+s .. #) this %as true* the -.0*000 should be considered as an opportunity cost. !his must be char'ed a'ainst the pro(ect* because it %ould ha0e been the cash $o% 'enerated i) the &rm didn+t proceed %ith the pro(ect. 2. !he net in0estment outlay is -,*500*000. !he terminal 0alue is -130*000. 4See computations 2.15 5. 6pon computin' the pro(ect+s #RR* 78* and M#RR* it can be seen that the pro(ect %on+t be pro&table. 1ith a net present 0alue belo% zero 49:;*<1;.;35* this pro(ect %on+t create 0alue )or the company+s shareholders. Moreo0er* it+s #RR and M#RR* :..,= and 3.0,=* respecti0ely* are belo% its cost o) capital. !hat means this pro(ect doesn+t e0en ma/e enou'h to 'o o0er its hurdle rate. 4See computations 2.15 <. !he de&nition o) incremental cash $o% %ould be di>erent i) the pro(ect in0ol0ed a replacement rather than e"pansion. #n e"pansion* incremental CF is de&ned as pro(ect+s cash in$o%s and out$o%s. !he company is comparin' the 0alue %ith and %ithout the proposed pro(ect. #n replacement* incremental CF is de&ned as the &rm+s additional in$o%s and out$o%s that result )rom in0estin' in the ne% pro(ect. !he company is comparin' the 0alue i) it ta/es the ne% pro(ect 0ersus the 0alue i) it continues on e"istin' assets. An e"ample %ould be seen in replacin' e?uipment* in doin' this* the 0alue o) the old e?uipment should also be ta/en into account. @epreciation %ould be ne%ly de&ned as the chan'e o) depreciation bet%een the installment o) ne% machine 0ersus continuin' the usa'e o) old machine. !his in e>ect %ould chan'e the cash $o%s o) the pro(ect. ;. 1e belie0e the pro(ect+s CF+s are in nominal terms because they are too lar'e. Assumin' a 5= in$ation* the latter CF+s %ould normally be less than the earlier CF+s* but in our case they are relati0ely e?ual. !his can )urther be (usti&ed because ta" shields on depreciation 4i) e0er there are5 do not increase %ith in$ation and stay constant in nominal terms because most ta" la%s only allo% the ori'inal cost o) the asset to be depreciated. !here)ore* the 1ACC should also be in nominal terms. !he 78 is biased because it o0erstates %hat may actually happen. !he economy may $uctuate and decrease the real 0alue o) the CF+s because o) in$ation. Ao%e0er* considerin' that it is only a 29year pro(ect* usin' nominal CF+s may not really be a poor estimation o) %hat may actually happen. :. 1hen in$ation is ta/en into account* the pro(ect+s 78* #RR* M#RR and paybac/ are the )ollo%in': -5<<*:5<.:,* 13.:.=* 15.;;= and ,.<2 years 4See !able :.19 :..5. 1e can see that the indicators ha0e impro0ed. !hese &'ures imply that the pro(ect becomes more 0iable %hen in$ation is considered. 3. !he sin'le cycle 78 o) ro(ects S and B are -1<*5,:.3. and -,2*;<1.3; 4!able 3.15. Because the 78s are computed %ith di>erent time spans* these 0alues cannot be used to assess the pro(ects. C0en %ith di>erent li0es* ma/in' the necessary ad(ustments can ma/e the t%o pro(ects comparable. 6sin' the replacement chain approach* the 78 o) ro(ects S and B are -.0*1:3.13 and -,2*;<1.3; 4!able 3..5. !he e?ui0alent annuities o) the pro(ects are -3*5,..:1 and -;*:11.<:* respecti0ely 4!able 3.,5. Based on these indicators* ro(ect S is the better option %hen the cost o) rene%in' the pro(ect is the same. #t yields a hi'her 78* -5*2,;.,, more than ro(ect B. 1hen the pro(ects are e"tended to a common li)e o) )our years* ro(ect S %ill yield -1*;1,.1. more in terms o) annuities. But i) the cost o) rene%in' ro(ect S is -2*,00*000* ro(ect B is more pro&table %ith an 78 that 'i0es -11*101.;0 more than ro(ect S 4!able 3.25. 10. #) the truc/ is used )or three years* its 78 is - 4.*,3<.;;5. #) it is used )or t%o years and sold* its 78 is -;<0.... #n the same %ay* the 78 o) the truc/ is - 45*030.315 i) used only )or a year and then sold. 4see !ables 10.1 and 10.,5 !hese 0alues are computed assumin' that the Cnd9o)9Dear 7et Abandonment Cash Flo%s pro0ided are a)ter9ta" &'ures. !his means that it is best to use the truc/ only )or t%o years and sell it. A)ter t%o years* the &rm has earned enou'h )rom the truc/ and at the same time* is able to sell it at a reasonable price. !he economic li)e o) the truc/ is , years. !his is because it is only at this time %hen the pro(ect %ill turn out to be pro&table )or the company. Cconomic li)e is de&ned as the span o) years it ta/es )or an in0estment to brea/ e0en. 11. a. 4See !able 11.15. 6pon ta/in' into account the said cash cost and sales price in$ation o) 5= per year* the pro(ect+s net present 0alue is no% positi0e at -10,*.53* thus ma/in' the pro(ect )a0orable to the &rm+s shareholders. !he positi0e net present 0alue is due to the hi'her net cash $o%s at the end o) years , to 2. !his increase in the cash $o%s also causes the pro(ect+s #RR to become 11.30=. !hus* e"ceedin' the pro(ect+s cost o) capital. !he pro(ect+s M#RR also increases to 11.11=* also abo0e the 10= cost o) capital. Moreo0er* a)ter in$ation* the pro(ect+s paybac/ period decreased to ..0<. Aence* the neutral in$ation increased the pro(ect+s pro&tability. b. #) this happens* the pro(ect %ould be e0en more unpro&table than it %as %ithout the in$ation. #ts net present 0alue %ould )urther decrease to 92;:*,<...0* indicatin' that it %ould pull the &rm do%n instead o) addin' 0alue to it. Moreo0er* its un9pro&tability can also be seen %ith its #RR o) 0.02=* %hich is %ay belo% the pro(ect+s cost o) capital. #ts M#RR o) 2..1= %hich is belo% its M#RR %ithout in$ation 43.0,=5* also indicates that the pro(ect is %orse o> than it %as %ithout in$ation. !his happens because %ith the increase in the cash costs* the pro(ect+s pro&t mar'in decreases* thus pullin' the net cash $o%s do%n%ard. 1,. a. #) in$ation rates %ere 5= on prices and ,= on cash costs* the company could sell the units at -.3 each in order to brea/9e0en. 4See !able 1,.15 b. #) cash costs increase by 5= annual in$ation %ithout a correspondin' increase in sales prices* the company %ould ha0e to sell 113*0:< units in order to brea/9e0en. 4See !able 1,.,5