Analysis of Investment Proposals of Canada Hardware
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This report contains an analysis of the relevant and irrelevant costs of the investment proposals of Canada Hardware. It uses various financial tools like NPV, IRR and others and concludes with a recommendation of the investment that the company should take up.
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Running head: ANALYSIS OF INVESTMENT PROPOSALS OF CANADA HARDWARE ANALYSIS OF INVESTMENT PROPOSALS OF CANADA HARDWARE Name of the Student Name of the University Author Note
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1 ANALYSIS OF INVESTMENT PROPOSALS OF CANADA HARDWARE Executive Summary This report contains an analysis of the relevant and irrelevant costs of the investment proposals of Canada Hardware. It uses various financial tools like NPV, IRR and others and concludes with a recommendation of the investment that the company should take up.
2 ANALYSIS OF INVESTMENT PROPOSALS OF CANADA HARDWARE Table of Contents Q3. Summary Narrative...............................................................................................................3 Description of Investment 1.........................................................................................................3 Description of Investment 2.........................................................................................................3 Time Horizons identified.............................................................................................................3 Relevant and Irrelevant Costs identified......................................................................................3 Q6. Evaluation of Two Investment Proposals.............................................................................3 Investment 1 Recommendation....................................................................................................3 Investment 2 Recommendation....................................................................................................4 References....................................................................................................................................5
3 ANALYSIS OF INVESTMENT PROPOSALS OF CANADA HARDWARE Q3. SummaryNarrative Description of Investment 1 In the given case, there are two investment proposals which are to be evaluated and selected. Investment 1 is related to expanding one of the existing facilities of the company and not taking over a distribution company to meet the growing demand for its apparel. This also includes the distribution of these manufactured products to its existing network of stores. This facility used in manufacturing cost $7000000 to purchase 10 years ago. Due to this expansion, CHI has an opportunity to nearly double its production in the near future. It will expand the production by 75% in the first year and at an annual rate of 10% in the years following that. The price of the products is measured at $30 which will increase at a rate of 2% in the coming years. The material and labour will cost @ 23% and 25% of the amount of sales. Other costs involved in this case will be the salaries of additional supervisors of $100000 and the insurance for the equipment and facilities at $80000. Overhead costs excluding depreciation are estimated to cost $500000 and wages are expected to increase with inflation. Additional trucks required for delivery would cost $100000 each and an annual insurance of $100000. The variable costs are expected to be at 15% of the incremental revenue. The expansion would cost an estimated $9000000 while the production equipment would cost an estimated $1000000 for a time of 6 years. Description of Investment 2 This investment proposal consists of turning several existing stores into restaurants for which 15 restaurants have been selected. These stores were purchased eight years ago. The cost of converting each store into a restaurant would cost $580000 with the CCA rate being mentioned at 6%. This investment is expected to generate an annual after-tax cash flow of $300000 while foregoing the revenue of $230000 previously being earned from the store. The stores were purchased for an amount of $1000000 each eight years ago. The new project is estimated to be invested for a period of 8 years. Time Horizons identified The time period allocated for investment 1 is a period of 6 years while the time horizon for the funds invested in investment 2 has been allocated for a period of 8 years.
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4 ANALYSIS OF INVESTMENT PROPOSALS OF CANADA HARDWARE Relevant and Irrelevant Costs identified Investment 1 relevant costs Investment1 irrelevant costs Investment 2 relevant costs Investment2 irrelevant costs Initial InvestmentCostofpurchasing the facility 10 years ago Costofinitial investment Costofpurchasing the facilities 8 years ago. Cost of inflationMaterialandlabour costs of the preceding years. Opportunity cost i.e. the revenue lost due toconvertingthe store. Material costCapitalconversion costs Labour Cost Transportation Insurance Supervisor Salary Other Overhead costs Q6. Evaluation of Two Investment Proposals Investment 1 Recommendation Investment 1 is to be made for a period of 6 years. It’s payback period is for a time of 1.28 years while the discounted payback period is for a time of 1.35 years. The IRR of this investment is measured at 82%, which is very high in general (Buettner & Wamser, 2015). This means that the project will have to produce a return of 82% in order to recover the investment that is being made by Canada Hardware. The tax shield provided is positive (Zwick & Mahon, 2017). The profitability index of this investment is measured at 5.76 which means that the project will provide the investor with a return of 5 times to his investment. In this case, NPV is a better option to use as the cash flows over the years are not constant and the existence of same
5 ANALYSIS OF INVESTMENT PROPOSALS OF CANADA HARDWARE discount rate over the years is not always possible (Weber, 2014). Hence it can be said that this investment is a highly risky one which should be taken up only if the company is able to bear the possibility of the investment being a failure. Investment 2 Recommendation Investment 2 has a negative NPV and also has a profitability index of 0.8. This project is not feasible when compared to project 1 and will serve the company with losses. Also, the tax shield provided and the profitability of this project is lower than that of Investment 1. This project should not be taken up by company 1.
6 ANALYSIS OF INVESTMENT PROPOSALS OF CANADA HARDWARE References Weber, T. A. (2014). On the (non-) equivalence of IRR and NPV.Journal of Mathematical Economics,52, 25-39. Buettner, T., & Wamser, G. (2013). Internal debt and multinational profit shifting: Empirical evidence from firm-level panel data.National Tax Journal,66(1), 63. Zwick, E., & Mahon, J. (2017). Tax policy and heterogeneous investment behavior.American Economic Review,107(1), 217-48. Neumann, P. J., Cohen, J. T., & Weinstein, M. C. (2014). Updating cost-effectiveness—the curiousresilienceofthe$50,000-per-QALYthreshold.NewEnglandJournalof Medicine,371(9), 796-797.