Capital Budgeting Analysis for Renovation and Replacement Projects

Here is a summary of the provided assignment content in a paragraph: The project's profitability index for both the renovation and replacement projects was calculated, revealing that the renovation project has a higher value. It was recommended to prioritize the renovation project over the replacement one. Additionally, the project's NPV was assessed at different WACC rates (25% and 15%), showing that the renovation project remains more profitable even at these rates. Finally, factors such as lower payback period, higher NPV, and IRR were identified as key considerations when selecting a project.

Business Finance

Table of Contents
INTRODUCTION...........................................................................................................................3
Question 1. Analyzing financial performance of Bank of Sydney..............................................3
Question 2 Assessment of the financial health and performance of Bradley stores....................5
Question 3 Bond valuation..........................................................................................................5
1. Finding yield to maturity of Horsham Industries bond...........................................................5
2. Stating the coupon yield of bond over the next years.............................................................5
3. Value of bond when risk class is 6.2%....................................................................................5
4. Assessing whether required rate of return such as 6.2% is suitable from investment purpose
.....................................................................................................................................................6
5. Finding the value of gain or loss in monetary terms...............................................................6
Question 4....................................................................................................................................8
1...................................................................................................................................................8
2...................................................................................................................................................8
3...................................................................................................................................................8
4.................................................................................................................................................10
Question 5 Portfolio evaluation.................................................................................................10
1. Calculating expected rate of return using probabilistic approach.........................................10
2. Finding standard deviations of the estimated rate of returns.................................................10
3. Assessing better measurement for the valuation of risk........................................................11
4. Identifying expected rate of return on the basis of beta.........................................................11
5. Portfolio beta and ERR..........................................................................................................11
6. Assessing beta of portfolio and ERR in the case of varied investment.................................12
7. Stating the portfolio which firm should prefer......................................................................12
Question 6 Evaluating the viability of proposed investment.....................................................13

1. Computing payback period and NPV....................................................................................13
3. Calculating IRR.....................................................................................................................14
4. Profitability index..................................................................................................................14
5. Recommendations..................................................................................................................15
6 and 7 Recommending project when NPV is 15%..................................................................15
8. Assessing NPV when WACC is 25%....................................................................................15
9. assessing the factors need to consider while making selection of project.............................16
CONCLUSION..............................................................................................................................16
REFERENCES..............................................................................................................................17

INTRODUCTION
In business, owner is required to take suitable decision that aid in the profit margin and
growth aspect of firm. The present report is based on different case situations which will shed
light on the concepts of bond or share valuation. Besides this, it will also develop understanding
regarding the concept of investment appraisal.
Question 1. Analyzing financial performance of Bank of Sydney
Ratio analysis
Profitability ratios
Particulars Formula Figures
Gross profit 50000
Net profit 6000
Net sales 300000
GP ratio
GP / net sales *
100 17%
NP ratio
NP / Net sales *
100 2%
Liquidity ratio analysis
Particulars Formula Figures Industry standard Performance level
Current assets 65000
Inventory 40000
Current liabilities 35000
Current ratio
Current assets /
current liabilities 1.86
2:1 Sound
Quick ratio
(current assets -
Inventory) /
current liabilities 0.71
.5:1 Sound

Activity ratios
Particulars Formula Figures
Inventory 40000
Accounts receivable 20000
Accounts payable 15000
COGS 250000
Sales 300000
Purchases 210000
Inventory turnover ratio COGS / inventory 6.25 times
Accounts receivable turnover
ratio Total credit sales / accounts receivable 15 times
Accounts payable ratio total purchase / accounts payable
14.00
times
Solvency or debt-equity ratios
Particulars Formula
Figure
s
Industry
standar
d
Performanc
e level
Long term debt 100000
Shareholders’
equity 65000
Debt-equity ratio Debt / equity 1.53
.5:1 Very high
as
compared
to ideal
ratio
Market ratios
Particulars Formula
Figure
s
Total dividends 900
Net income 30000
Outstanding shares 10000
Earnings per share (Net income - preferred dividend) / average outstanding 2.91

shares
Dividend payout
ratio Total dividends / net income 0.03
Question 2 Assessment of the financial health and performance of Bradley stores
a.
Liquidity ratios
Particulars Figures
Current ratio 1.5 times
Quick ratio 1.25 times
Outcome of ratio analysis presents that liquidity position and performance of Bradley
store is sound. Standard current and quick ratio is 2:1 & .5:1 respectively. Thus, it can be stated
that quick ratio of store is very high. On the basis of this aspect, it is recommended to the firm
start making investment which in turn helps it in attaining higher profit margin.
b.
Activity ratios
Particulars Figures
Average collection period 30 days
Inventory turnover ratio 12
Average payment period 20 days
Fixed assets turnover ratio 1.8
Total assets turnover ratio 1.4
Return on assets 9%
The above depicted table presents that business entity of Bradley store receives money
later and payment is made by it earlier. Hence, for ensuing proper balance in working capital
business entity is required to revise credit policy. Further, fixed and total asset turnover ratio of
the firm is neither too high nor too lower. Thus, firm is required to encourage their personnel for
making best efforts and making optimum use from assets.

c.
Solvency ratio
Particulars Figures
Debt-equity ratio 50% or .5:1
Ratio analysis presents that debt-equity ratio is .5:1 which is equal to ideal ratio. Hence, it
can be stated that capital structure of Bradley store is highly balanced and optimal.
d.
Profitability ratios
Particulars Figures
Net profit margin 6.4%
Return on equity 18%
NP margin of Bradley store accounts for 6.4 % which is higher. Hence, firm needs to
make control on direct and indirect expense level. By doing this, profit can be enhanced by firm
to a great extent. Further, Bradley needs to make modifications in the current strategic and policy
framework. This in turn helps in making optimum use from shareholder’s equity.
e.
From evaluation, it has been assessed that financial position of Bradley store is good at
marketplace in against to industry average. However, company needs to make efforts in relation
to maximizing profit margin and reducing the level of expense.
f.
It is recommended to the owner to approve loan by taking into account the liquidity
position and profitability aspect of firm. Hence, owner should make focus on the approval of
loan for companies whose position is in line with the industry average.
Question 3 Bond valuation
1. Finding yield to maturity of Horsham Industries bond
Particulars Figures
Face value $100

Annual coupon rate 5.550%
Years to maturity (from 2008 to 2037) 31 years
Coupon payments per year 2
Current bond price $96.12
Yield to maturity 5.82%
2. Stating the coupon yield of bond over the next years
Coupon yield of this bond will fluctuate over the years according to high low range.
Hence, by considering such aspect it can be said that value of yield will increase in the near
future because it comes under the category of Aa3 (Fraser, Bhaumik and Wright, 2015).
3. Value of bond when risk class is 6.2%
Year
Cash
flow
PV factor
@ 6.2%
Discounte
d cash
flow
1 5.55 0.942 5.23
2 5.55 0.887 4.92
3 5.55 0.835 4.63
4 5.55 0.786 4.36
5 5.55 0.740 4.11
6 5.55 0.697 3.87
7 5.55 0.656 3.64
8 5.55 0.618 3.43
9 5.55 0.582 3.23
10 5.55 0.548 3.04
11 5.55 0.516 2.86
12 5.55 0.486 2.70
13 5.55 0.457 2.54
14 5.55 0.431 2.39
15 5.55 0.406 2.25
16 5.55 0.382 2.12
17 5.55 0.360 2.00
18 5.55 0.339 1.88
19 5.55 0.319 1.77
20 5.55 0.300 1.67
21 5.55 0.283 1.57

22 5.55 0.266 1.48
23 5.55 0.251 1.39
24 5.55 0.236 1.31
25 5.55 0.222 1.23
26 5.55 0.209 1.16
27 5.55 0.197 1.09
28 5.55 0.186 1.03
29 5.55 0.175 0.97
30 5.55 0.165 0.91
31 5.55 0.155 0.86
32 5.55 0.146 0.81
33 5.55 0.137 0.76
34 5.55 0.129 0.72
35 5.55 0.122 0.68
36 5.55 0.115 0.64
37 105.55 0.108 11.40
Bond value 90.65
4. Assessing whether required rate of return such as 6.2% is suitable from investment purpose
Value of bond will decrease to the significant level such as $90.65 if required rate of
return increases. Thus, business unit should avoid making investment in the bond of Horsham
Industries.
5. Finding the value of gain or loss in monetary terms
Year
Cash
flow
PV
factor
@
6.2%
Discounte
d cash
flow
1 6 0.942 5.65
2 6 0.887 5.32
3 6 0.835 5.01
4 6 0.786 4.72
5 6 0.740 4.44
6 6 0.697 4.18
7 6 0.656 3.94
8 6 0.618 3.71
9 6 0.582 3.49
10 6 0.548 3.29

11 6 0.516 3.10
12 6 0.486 2.92
13 6 0.457 2.74
14 6 0.431 2.58
15 6 0.406 2.43
16 6 0.382 2.29
17 6 0.360 2.16
18 6 0.339 2.03
19 6 0.319 1.91
20 6 0.300 1.80
21 6 0.283 1.70
22 6 0.266 1.60
23 6 0.251 1.50
24 6 0.236 1.42
25 6 0.222 1.33
26 6 0.209 1.26
27 6 0.197 1.18
28 6 0.186 1.11
29 6 0.175 1.05
30 6 0.165 0.99
31 6 0.155 0.93
32 6 0.146 0.88
33 6 0.137 0.82
34 6 0.129 0.78
35 6 0.122 0.73
36 6 0.115 0.69
37 106 0.108 11.45
Bond value 97.12
In comparison to par value such as 100, investor will suffer loss of $3. However, such
bond purchased by the company @ $96.124 and today’s bond value is 97.12. This aspect shows
the gain of $.99. Hence, by considering the overall scenario or situation it can be stated that
investor will earn profit by investing money in such bonds.
Question 4
1.
If business unit such as Wild Rydes Pty Ltd will offer 100% earnings in the form of
dividend then it may result into high decline in share value such as near to zero. Moreover, when

business unit does not have fund for making investment in other profitable opportunities then it
may result into decline in share price or image.
2.
Earning method of share valuation
Particulars
Figure
s
Income 300000
Pay-out ratio 30% 90000
Net income 210000
Shares in number 50000
EPS 4.2
Price per share 450
price earnings ratio
107.14
3
Value of share 450
3.
Dividend growth method of share valuation:
Given that
Particulars Figures
Dividend per share 1.5
K or payout ratio 12%%

G1 50%
G2 20%
G3 20%
Gn 9%
Dividen
d
Figur
es
D1 1.5
D2 2.25
D3 1.8
D4 1.8
D5 1.64
Working note: Value of 5th year
= 1.64 / (.30 - .09)
= $7.79
S. No. Value of dividend
Payout
ratio
or PV
factor
@
30%
Discounted
amount
1 1.5 0.893 1.34

2 2.25 0.797 1.79
3 1.8 0.712 1.28
4 1.8 0.636 1.14
5 7.79 0.567 4.42
Value
of
stock 9.98
4.
The main reasons behind different project valuation are the adoption of different
methods as well as tools or techniques.
Question 5 Portfolio evaluation
1. Calculating expected rate of return using probabilistic approach
Economy
Probabilit
y (1)
Tech.co
m (2)
Sam's
grocer
y (3)
ASX
200 (4)
ERR of
Tech.co
m (1 * 2)
ERR of
Sam's
grocer
y (1 *
3)
ERR
of
ASX
200 (1
* 4)
Recession 30% -20% 5% -4% -6.00% 1.50% -1.20%
Average 20% 15% 6% 11% 3.00% 1.20% 2.20%
Expansion 35% 3% 8% 17% 1.05% 2.80% 5.95%
Boom 15% 5% 10% 27% 0.75% 1.50% 4.05%
ERR 11%
2. Finding standard deviations of the estimated rate of returns
Computation of standard deviation of estimated rate of return
Economy
Tech.co
m
Sam's
grocer
y
ASX
200
Recession -20% 5% -4%
Average 15% 6% 11%
Expansion 3% 8% 17%
Boom 5% 10% 27%

Standard
deviation 0.15 0.02 0.13
3. Assessing better measurement for the valuation of risk
Both standard deviation and beta helps in assessing the risk level that is associated with
securities. However, beta is highly significant which in turn helps in making idea regarding the
extent to which specific security is highly risky (Gertler and Kiyotaki, 2010).
4. Identifying expected rate of return on the basis of beta
Company Beta
expecte
d
return Rf
Expecte
d rate of
return
Tech.com 1.68 1% 1.50% 1%
Sam's
grocery 0.52 7% 1.50% 4%
5. Portfolio beta and ERR
Company name
Investme
nt
amount
Weig
ht Beta
Portfoli
o beta
(weight
* beta)
Tech.com 30000 0.3 1.68 0.50
Sam's grocery 70000 0.7 0.52 0.36
Total 100000 0.87
Expected rate of return
Company
Average
estimate
d rate of
return Weight
(Average
return *
weight)
Tech.com 1% 0.3 0.003
Sam's
grocery 7% 0.7 0.05
Expected 0.05 or

rate of
return 5%
6. Assessing beta of portfolio and ERR in the case of varied investment
Company name
Investme
nt
amount
Weig
ht Beta
Portfoli
o beta
(weight
* beta)
Tech.com 70000 0.7 1.68 1.18
Sam's grocery 30000 0.3 0.52 0.16
Boom 15% 5% 10% 1.33
Expected rate of return
Company
Average
estimate
d rate of
return
Weig
ht
(Averag
e
return
*
weight)
Tech.com 1% 0.7 0.007
Sam's
grocery 7% 0.3 0.02
Expected
rate of
return
0.03 or
3%
7. Stating the portfolio which firm should prefer
From assessment, it has been identified that investment portfolio 1 should be preferred by
the investors. On the basis of this aspect $30000 in Tech.com and $70000 must invest in Sam’s
grocery.
Question 6 Evaluating the viability of proposed investment
1. Computing payback period and NPV
Renovation project

Year
Ca
sh
infl
ow
cumula
tive
cash
inflow
PV
factor
@
15%
Discou
nted
cash
inflow
1
30
00
00
0
300000
0 0.870
260869
5.652
2
30
00
00
0
600000
0 0.756
226843
1.002
3
30
00
00
0
900000
0 0.658
197254
8.697
4
30
00
00
0
120000
00 0.572
171525
9.737
5
30
00
00
0
150000
00 0.497
149153
0.206
Total
discounte
d cash
inflow
100564
65.29
Less:
initial
investme
nt
900000
0
NPV
105646
5.294
payback
period
3
years
Replacement project
Year Cash cumulative cash PV factor @ Discounted cash

inflow inflow 15% inflow
1 2000000 2000000 0.870 1739130.43
2 800000 2800000 0.756 604914.93
3 200000 3000000 0.658 131503.25
4 200000 3200000 0.572 114350.65
5 200000 3400000 0.497 99435.35
Total discounted cash
inflow 2689334.61
Less: initial investment 2400000
NPV 289334.61
Payback period: 1 + 400000 / 800000
= 1 + .5
= 1.5 years
3. Calculating IRR
Replacement project
Year -2400000
1 2000000
2 800000
3 200000
4 200000
5 200000
IRR 24%
Renovation project
Year -9000000
1 3000000
2 3000000
3 3000000
4 3000000
5 3000000

IRR 20%
4. Profitability index
Renovation project
Profitability index: 1 + NPV / initial investment
= 1 + 289334.61 / 2400000
= 1 + .12
= 1.12
Replacement project
Profitability index: 1 + NPV / initial investment
= 1 + 289334.61 / 2400000
= 1 + .12
= 1.12
5. Recommendations
It is recommended to Contract manufacturing Ltd to lay emphasis on selecting renovation
project rather than replacement.

6 and 7 Recommending project when NPV is 15%
Renovation Replacement
0
200000
400000
600000
800000
1000000
1200000
NPV (In $)
NPV (In $)
It is suggested to business organization to employ renovation project which in turn proves
to be more beneficial for it.
8. Assessing NPV when WACC is 25%
Renovation project
NPV when WACC is 25%
Year Cash inflow PV factor @ 25%
Discounted cash
inflow (in $)
1 3000000 0.800 2400000
2 3000000 0.756 2268431.00
3 3000000 0.658 1972548.70
4 3000000 0.572 1715259.74
5 3000000 0.497 1491530.21
Total discounted cash
inflow 9847769.64
Less: initial investment 9000000
NPV 847769.64
Calculation of NPV when WACC is 25%

Year Cash inflow PV factor @ 15%
Discounted cash
inflow
1 2000000 0.800 1600000.00
2 800000 0.756 604914.93
3 200000 0.658 131503.25
4 200000 0.572 114350.65
5 200000 0.497 99435.35
Total discounted cash
inflow 2550204.18
Less: initial investment 2400000
NPV 150204.18
9. assessing the factors need to consider while making selection of project
Business entity or analyst should consider lower payback period and higher NPV and
IRR while making selection of project (Götze, Northcott and Schuster, 2015).
CONCLUSION
From the above report, it has been concluded that by using bond and share valuation
techniques firm can take suitable decision. Besides this, it can be inferred that investment
appraisal techniques assist in evaluating the viability if project in an effectual way.