Financial Strategy - Assignment

2021
Assignment 1
FINANCIAL STRATEGY

Contents
Calculations............................................................................................................................. 2
Task 1 – What is the payback period of the project? ............................................................. 3
Task 2 – What is the profitability Index of the project? ......................................................... 4
Task 3 – What is the IRR of the project? ................................................................................ 4
Task 4 – What is the NPV of the project? ............................................................................... 5
Task 5 – How sensitive is the NPV to changes in the price of the new smartphone? ........... 5
Task 6 – How sensitive is the NPV to changes in the quantity sold? ..................................... 7
Task 7 – Should EMU Electronics produce the new smart phone?........................................ 8
Task 8 – Suppose EMU Electronics loses sales on other models because of the introduction
of the new model. How would this affect your analysis? ...................................................... 9
Bibliography .......................................................................................................................... 10

Calculations
EMU electronics is going to invest in developing a new and more enhanced smartphone,
however, the company must take a lot of factors into consideration before deciding if the
investment will be profitable. To find out if the investment will be profitable, it is necessary
to calculate the information that has been given to be able to find the payback period,
profitability index, the IRR and the NPV. In year 0 the initial investment is recorded and that
is the plant and machinery, what the company invested in the marketing research and the
prototype development of the new product. In years 1 to 5 we can see the cash flow from
the sales of the new smartphone, it is known that the price per unit is 485 and we have
information on how many units were sold from years 1-5. From the cashflow information
that has now been gathered it is time to subtract the variable cost which was 205 per unit
and the fixed cost and lastly the depreciation as can be seen in table 1. After that the pre-
tax cash flow has been calculated.
Table 1 – Pre-tax cash flow
Year Cash flow Variable cost Fixed cost Depreciation Pretax CF
0 - 35.450.000 - 35.450.000
1 31.040.000 - 13.120.000 - 5.100.000 5.800.000 18.620.000
2 51.410.000 - 21.730.000 - 5.100.000 5.800.000 30.380.000
3 42.195.000 - 17.835.000 - 5.100.000 5.800.000 25.060.000
4 37.830.000 - 15.990.000 - 5.100.000 5.800.000 22.540.000
5 26.190.000 - 11.070.000 - 5.100.000 5.800.000 15.820.000
Now it is time to find the cash flow after tax, it is known that the tax is 30% so it is necessary
to multiply the cashflow with 30% each year and then subtract it to the pre-tax CF to find
the after-tax cash flow. Next step is to apply the required return to the after-tax cash flow
to get the present value, this needs to be done to adjust the time value of the money. The
formula used to find the required return is: 1/(1+r)n where: n: the year of cashflow r: rate.

(Pike and Neale, 2009) After having calculated the required return, we multiply that with
the after-tax cashflow and get the present value. The calculations can be seen in table 2.
Table 2 – Tax and present value
Year Tax 30% CF after tax Required return 12% Present value
0 - 35.450.000 1 - 35.450.000
1 - 5.586.000 13.034.000 0,892857143 11.637.500
2 - 9.114.000 21.266.000 0,797193878 16.953.125
3 - 7.518.000 17.542.000 0,711780248 12.486.049
4 - 6.762.000 15.778.000 0,635518078 10.027.204
5 - 4.746.000 11.074.000 0,567426856 6.283.685
NPV 21.937.563
Task 1– What is the payback period of the project?
The payback period is an approach that is used to analyse investments and gives
information on how long it takes for the future cash flow to match the initial cash outlay, or
just in simpler words how long does it take for an investment to be profitable? (Pike and
Neale, 2009)
The formula is: (initial investment – opening cumulative CF)/(closing – opening CF)
By using the information from table 3 and using the formula:
Payback period = we get 2 + (1.150.000/17.452.000) = 2,066 years
Table 3 – Payback period
Payback period
Year Annual CF Cumulative CF
0 - 35.450.000 - 35.450.000
1 13.034.000 - 22.416.000
2 21.266.000 - 1.150.000
3 17.542.000 16.392.000
4 15.778.000 32.170.000
5 11.074.000 43.244.000

Task 2– What is the profitability Index of the project?
The profitability index describes the relationship between the cost and benefits of a
proposed project. If the Profitability index is greater than 1 the project is considered
acceptable. (Pike and Neale, 2009)
The formula is: PI = PV benefits/PV outlay
By using the information from table 2, it is possible to calculate the Profitability Index.
PI = (21.937.563+35.450.000)/35.450.000 = 1,62.
Because the PI is greater than 1 the project is considered acceptable.
Task 3– What is the IRR of the project?
IRR or initial rate of return gives information on the rate of return that an investment will
provide based on the amount of the original investment that remains outstanding during
any period, combining the interest annually. Using the IRR rate involves changing the
discount rate so the NPV will be equal or close to zero, if the IRR is greater than
predetermined discount rates the investment should be accepted. (Pike and Neale, 2009)
The formula is: IRR = DR1+(DR2-DR1)*NPV1/(NPV1-NPV2)
Table 4 – Initial rate of return
IRR
Year CF after tax
Required
return 12% PV Required return 35% PV
0 - 35.450.000 1 - 35.450.000 1 - 35.450.000
1 13.034.000 0,892857143 11.637.500 0,738924384 9.631.140
2 21.266.000 0,797193878 16.953.125 0,546009245 11.611.433
3 17.542.000 0,711780248 12.486.049 0,403459545 7.077.487
4 15.778.000 0,635518078 10.027.204 0,298126095 4.703.834
5 11.074.000 0,567426856 6.283.685 0,220292641 2.439.521
NPV 21.937.563 NPV 13.415

Using the information available from table 4 it is known that:
DR1 = 12% NPV1 = 21.937.564
DR1= 35% NPV2 = 13.415
IRR = 12%+(35%-12%)-21.937.564/(21.937.564-13.415) = 0,35
This gives information that the IRR is slightly above 35%, therefore, the project should be
accepted because the IRR is higher than the predetermined required return which is 12%.
Task 4– What is the NPV of the project?
NPV or net present value is the difference between the present value of cash inflows and
the present value of cash outflow over a period of time and is used to analyse the
profitability of a investment. If the NPV is greater than 1 it means that the project should
be accepted. (Investopedia, 2021)
The formula:
Where: Rt = Net cash inflow-outflows during a single period t
i = Discount rate or return that could be earned in alternative investment
t = number of time periods
As can be seen in table 2 and table 4 the NPV is the sum of the PV or 21.937.563. The NPV
is a positive number which means that the project should be acceptable.
Task 5– How sensitive is the NPV to changes in the price of the new
smartphone?
To find how sensitive the NPV is to changes in the price it is necessary to look at what the
NVP would be in different prices. The actual price is 485 per unit, let’s make the price 10%
lower and 10% higher and see what the NPV is based on the higher and lower prices. (Lumby
and Jones)

Table 5 – NPV at different prices.
Unit price NPV
10% lower 436,5 12.303.173
Actual price 485 21.937.563
10% higher 533,5 31.571.954
From table 5 it is clear that when the price goes down the NPV goes down and when the
price goes up the NPV goes up, but how sensitive is the NPV to the changes in price? Let’s
put table 5 into a graph.
Graph 1
From the graph it is possible to find the slope/steepness, the formula for that is:
Slope = Rise/Run = (y2-y1)/(x2-x1)
Slope = (21.937.563-12.303.173)/(485-436,5) = 198.647
For every unit of x, how far does y move? Y moves by 198.647 or in other words for every
change in the price the NPV moves by 198.647.
-
10.000.000
20.000.000
30.000.000
40.000.000
400 420 440 460 480 500 520 540 560
NPV
Price
How sensetive is the NPV to changes in the price of the new
smartphone?

Task 6– How sensitive is the NPV to changes in the quantity sold?
To find how sensitive the NPV is to changes in quantity sold like in the earlier task it is
necessary to find out what the NPV will be based on higher and lower quantities sold. Lets
see what the NVP will be based on 10% higher and lower quantities sold.
Table 6 – NPV at different amounts units sold
year Units sold NPV
10% Lower 1 57.600
16.375.441
2 95.400
3 78.300
4 70.200
5 48.600
Actual units 1 64.000
21.937.563
2 106.000
3 87.000
4 78.000
5 54.000
10% higher 1 70.400
27.499.686
2 116.600
3 95.700
4 85.800
5 59.400
From table 6 we can see that when units sold go down the NPV also goes down and the
other way around, when the unit sold go up the NPV goes up too. We are unable to put
table 7 into a graph, however, it is possible to find the average of the actual units sold from
year 1-5 which is 77.800 and then find out what 10% increase and decrease of 77.800 units
sold would be and based on that information find out what the NPV is. (Lumby and Jones)
Table 7 – NPV at different amounts units sold
Units sold NPV
10% lower 70.020 15.788.001
Correct 77.800 21.284.852
10% higher 85.580 26.781.703
Now let’s put table 8 into a graph:

Graph 2
From the graph we can find the slope/steepness, the formula for that is:
Slope = Rise/Run = (y2-y1)/(x2-x1)
Slope = (21.284.852-15.788.001)/(77.800-70.020) = 706
For every unit of x, how far does y move? Y moves by 706 or in other words for every unit
that changes the NPV moves by 706.
Task 7– Should EMU Electronics produce the new smart phone?
The IRR is 35%, or higher than the required return that is 12%, therefore, the project should
be accepted.
The profitability index is 1,62, therefore, the PI exceeds 1 and the project should be
accepted.
The Net Present Value is 21.937.563, therefore, the NPV exceeds 1 and the project should
be accepted.
According to all the calculations that have been done with the PI, IRR and NPV it is clear that
the project should be accepted and it is expected to be a success.
15.000.000
17.000.000
19.000.000
21.000.000
23.000.000
25.000.000
27.000.000
29.000.000
65.000 70.000 75.000 80.000 85.000 90.000
NPV
Units sold
How sensitive is the NPV to changes in the quantity
sold?

Task 8– Suppose EMU Electronics loses sales on other models
because of the introduction of the new model. How would this affe
your analysis?
When a company introduces a new product to the market that is somewhat like their other
existing products it is very likely that they will lose sales on the existing products as a result
of the customer base wanting to purchase newer products. This term is called market
cannibalization and could lead to no increase in the company’s market share despite the
sales growth of the new product. (Investopedia, 2021)
When it comes to the analysis that I have performed the result is that this does not have an
effect on it in my opinion. The effect that the losing of sales on other models could have is
more on the company itself, however, even if the company will lose an amount on sales on
other products it is gaining sales on the new product that they are introducing to the
market.

Bibliography
Investopedia. (2021). Net Present Value (NPV). [online] Available at:
https://www.investopedia.com/terms/n/npv.asp [Accessed 3 Mar. 2021].
Pike, Richard, and Bill Neale. Corporate Finance and Investment : Decisions and
Strategies. Harlow, Financial Times/Prentice Hall, 2009.
Lumby, Stephen, and Chris Jones. Corporate Finance : Theory & Practice. Andover,
South-Western Cengage Learning, 2011.
Investopedia. (2021). Understanding Market Cannibalization. [online] Available at:
https://www.investopedia.com/terms/m/marketcannibilization.asp [Accessed 3 Mar. 2021].