Business Finance - Assignment PDF

Running head: BUSINESS FINANCE
Business finance
University Name
Student Name
Authors’ Note

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Table of Contents
Introduction:...............................................................................................................................3
Discussion:.................................................................................................................................3
Answer to question 1:.................................................................................................................6
Answer to question 2:.................................................................................................................8
Answer to question 3:.................................................................................................................9
Answer to question 4:...............................................................................................................10
Answer to question 5:...............................................................................................................10
Requirement a).........................................................................................................................10
Requirement b).........................................................................................................................12
Requirement c).........................................................................................................................12
Answer to question 6:...............................................................................................................16
Conclusion:..............................................................................................................................16
Reference list and Bibliography:..............................................................................................17

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Case study: Radiant laundry Product Company
Introduction:
This particular assignment intends to evaluate the project by employing techniques of
capital budgeting. Analysis of the project is done by answering the questions concerning the
project. The radiant laundry product company is the leading producer of laundry detergent
having two major product lines that is traditional power detergent and concentrated power
detergent. Project that is considered by the company is intended to involve in the production
of new product that is a liquid detergent product called FAB. It is perceived by company that
this product have advantage over the conventional detergent product in terms of better
cleaning capabilities, reduced usage of detergent and easier to control and use. The packaging
facilities new production equipment for the production of new liquid detergent are proposed
to be sourced from two organizations that is Donnalley limited and Danforth limited. Several
parameters that are associated with making investment in Donnalley limited are that the
estimated life of investing in this particular project is ten years having an expected salvage
value of $ 80000. The rate of depreciation assumed for the packaging and equipment
facilities stood at 35% and the depreciation will be done on a reducing balancing basis. On
other hand, investing in Danforth project would initially cost $ 1.3 million and this comprise
of packaging facilities and equipment. This will help in reducing the cost of debt to $ 0.8
million compared to $ 1.5 million. The expected life of new equipment would be five years.
The total life time of this particular project would be ten years. All the questions answered
below would be in conducting the in depth analysis of the projects that the company is
seeking to undertake for producing the liquid detergent. However, in order to make
investment in Donalley would require additional working capital of $ 100000.

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Discussion:
Capital budgeting is the technique that is used by business enterprise or individual for
big investment projects and it is used for evaluating whether a particular project undertaken is
feasible enough to make investment in. there are two concepts involved in the analysis of the
projects that is future or initial outlays that is expected for the acquisition of assets and
expected flows of cash that is generated by assets utilization. There are two criteria of capital
budgeting techniques or the investment appraisal tool that is discounted cash flow criteria and
non discounting cash flow criteria (Alhabeeb, 2016).
Evaluation of project is done by using both the criteria of tool of appraisal. The
techniques used under the discounting cash flow criteria are net present value, profitability
index and internal rate of return (Longin, 2016). On other hand, non discounted cash flow
criteria make use of accounting rate of return and payback period as the appraisal tool.
For evaluating the investment projects, one of the well known methods is technique of
net present value. The acceptance or rejection of project depends upon the figures of net
present value. A positive value is usually indication of the fact that the project should be
accepted and a negative value depicts that the project should be rejected. In this method, the
present valuation of the future value of cash flow is computed by using an appropriate
discounting rate. Another method of evaluation of project is internal rate of return that is the
rate at which the net present value of project is zero. For the purpose of evaluation of project,
it is required by investor to make comparison between the internal rate of return and the cost
of capital of organization. Investors should make acceptance of the project if the cost of
capital is lower than the internal rate of return (Balakrishnan et al., 2016). On other hand, the
project should be rejected if the cost of capital is more than internal rate of return.

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Profitability index is another discounted cash flow method that is used by investors to
evaluate the project. It is a technique of investment appraisal that is obtained by dividing
present value of future cash flow by the initial amount of investment made by business
enterprises. This particular method of capital budgeting helps in ranking of the investment
and it assist on deciding on the best investment that should be made. Investors should accept
the project is the profitability index of the project is more than one and the project should be
rejected if the profitability index is less than project. This is so because a positive value of
profitability index is indicative of the fact that future cash flow present value of project is
more than the initial amount of investment that is made. Moreover, there is loss of investment
if the value of profitability index is less than one (Rossi, 2014). On other hand, if the value of
profitability index is equal to one would indicate that the project is not generating any profits.
Therefore, it is an analysis tool that would help investors whether they should undertake any
particular project or not.
Payback period on other hand is an evaluation method that does not take into
consideration the discounting factor. Payback is the time period that is taken by the project
for recovering the initial amount of investment that has been made (Moffett et al., 2016).
Moreover, it is used or measuring whether the project is inherent to risk and the tool is the
indication of how certain the cash inflow of the project is. It provides Radian laundry Project
Company with the quick picture of the amount of time that the initial amount of investment
will be at risk.
Accounting rate of return is the rate that makes use of arithmetic mean of accounting
income that is expected to be earned by the project to the average amount of investment
made. It is obtained by dividing average accounting profit by average amount of investment
that is made. Investors should accept the project if the accounting rate of return is greater than

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the required rate of return or cost of capital. It helps investors in deciding about making
(Chung et al., 2015).
All the above techniques of capital budgeting are used by Radiant laundry Product
Company for evaluating the project that they are seeking to undertake for manufacturing
liquid detergent as it would require new equipments and production facilities.
Answer to question 1:
The evaluation of the project of manufacturing liquid detergent seeks investment in
two enterprises that is Donnalley limited and Danforth Limited. This particular question is
about recommending the Radiant laundry company for purchasing packaging facilities and
specialized equipment from either Danforth limited and Donnalley limited. Both the projects
are evaluated using the techniques of capital budgeting.
Considering making investment in Donnalley project with the total initial amount of
investment stood at $ 2000000. It can be seen that in the first two years of operation, the
project has generated net operating cash flow of amount $ 464400 and $ 514500 respectively.
The total amount of net operating profit has decreased initially from $ 356295 to $ 349692 in
the first year of operation and eventually in reduced in the later year of operation. Project
generated reduced profit of $ 349692 in the third year of operation to $ 347350 in the later
year of operation.
Now, looking at the figure of net present value, it can be seen that net present value of
project stood at -$ 191880. The internal rate of return of the project stood at 18.01% and the
profitability index stood at 1.10. Based on the value generated for the project, it is inferred
that project should be rejected. It can be seen that the net present value of project is negative.
Furthermore, the profitability index is lower than one that is indicative of the fact that making
investment in project will not be generating profit.

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Now, looking at the figures of investment project made in Danforth Limited, it can be
seen that the total amount of investment that is required to be made in the project stood at %
1300000. It can be seen from the figures depicted in the table that the net profit generated
from the project is increasing initially from $ 409200 in first year of operation to $ 523800 in
the fifth year of operation. Profit, on other hand has started reducing since seventh year of
operation to $ 410800 and $ 399100 in the last year of operation. The net present value of the
project computed stood at $ 432034 and the internal rate of return stood at 25.97%.
Profitability index of project on other hand stood at 1.33 with payback period at 2.78. It is
generated by the figures that net present value of project is positive and the value of internal
rate of return is more than the required rate of return. Therefore, it is viable to accept the
project. In addition to this, the payback period of the project invested in Danforth Limited is
less compared to making investment in project Donnalley limited.
Now, the investment project made in Danforth Limited is evaluated by taking into
account inflation factor. Here, the total amount of investment to be made in the project
Danforth limited stood at $ 1300000 and the time taken for the project is ten years. It can be
seen from the table that there is continuous increase in net profit and the net profit after
taxation is also increasing continuously. There is much fluctuation in net operating cash flow
as the value has initially increased to $ 513905 as against $ 409200. In later part of year, net
profit has increased further to $ 553635 and again declined to $ 415790 respectively. For the
computation of net present value, the discount rate that has been assumed by Radiant laundry
Product Company stood at 15%. The net cash flow in this particular investment project is
generating an increasing cash flow in the initial years of operation that is the cash flow
generated stood at $ 409200 in first year of operation to $ 508788 in the fifth year of
operation. The net cash flow on other hand declined to negative value to -$ 786095 in sixth
year of operation. Reason is attributable to the fact that company is required to make

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investment again in sixth year of operation. After making investment, it can be seen that net
cash flow stood at $ 553635 and the net cash flow initially reduced to $ 465790 and thereafter
it reduced to $ 465790. The net present value of project stood at $ 481334 with a payback
period of 2.74. On other hand, the internal rate of return of the project stood at 27.01% that is
above the required rate of return. It can be seen that when considering the inflation factor, the
net present value generated by project is higher compared to net present value when inflation
factor is not accounted for. Moreover, the payback period of project stood at 2.74 as against
1.33 when inflation is not considered.
Therefore, from the analysis of above figures, it can be inferred that it would be
profitable to make investment in Danforth limited. The reason is attributable to a positive net
present value, lower payback period and higher internal rate of return (McLean & Zhao,
2014).
Answer to question 2:
Based on the evaluation of the given projects, making investment in Danforth Limited
is considered viable and hence, Radian laundry Project Company would consider making
investment in this particular project. The cash flow table is prepared for the Danforth limited
take into account several factors such as initial amount, terminal and operating cash flow.
The cost of market testing of $ 150000 is not included in the cash flow table for
preparing cash flow value of the project Danforth limited. The reason is attributable to the
fact that the cost of market testing is nit regarded as relevant costing factor in the computation
the viability of the project. In addition to this, the interest expense is on fixed term loan at the
rate of 10% for financing the project is not incorporated in the cash flow table. This is so
because the interest rate has always been included in the cash flow table. Therefore, it is not
essential to include the amount of interest expense in the cash flow table.

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The amount of initial working capital investment of $ 100000 is not included in the
preparation of cash flow table. The cash outflow of this particular amount as a part of capital
investment is not worthy as this amount would always be in the liquid form and would never
leaving the company. It is for this reason that this amount of working capital investment
would not be included in the cash flow table preparation. On other hand, preparation of cash
flow table would incorporate the requirement of annual working capital at the rate of 12%.
The items of erosion of sales from current laundry detergent project would be
included in the cash flow table preparation. This is so because for ascertaining the net sales
figures before and after the launching of new product can be determined by taking into
consideration the figure of sales erosion.
Furthermore, it is required by business enterprise to include the annual cost of renting
of $ 120000. This is so because it would help in identifying the actual amount of revenue that
would be generated by business by using this particular space. The current excess plant
facilities should be charged something during then project. For determination of the
parameters for evaluating the competitiveness of this project with other projects, it is required
to treat it as some outside project as the firm would be charged with the same amount if this
particular space is rented by some outside firms (Young & Pagliari, 2017).
Answer to question 3:
It can be seen from the above table that the chosen project for making investment is
Danforth Limited. The payback period of this particular project stood at 2.78 when inflation
is not considered. On other hand, when taking inflation into account, the payback period
stood at 2.74. Based on this particular appraisal tool, it is feasible to accept this project as the
payback period is lower compared to Donnalley project. Now, looking at the figure of
internal rate of return, it can be seen that the rate stood at 25.97% and the rate is higher than

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the required rate of return of the project. Therefore, as per the acceptance criteria for internal
rate of return, the project should be accepted. Now, looking at the figure of profitability
index, it is depicted from the computation that the value stood at 1.37. The acceptance criteria
of project for the profitability index are that the value should be more than one (Young &
Pagliari, 2017). Since, the value of profitability index is more than one, the project should be
accepted.
Answer to question 4:
The answer derived in the question would be impacted if there is rejection of the FAB
project as the competitor would introduce the new similar product. In addition to this, the
acceptance or rejection of the project would depend upon the revised computed value. This is
so because; the new value of the project would be computed by conducting several external
and internal factors. Radiant laundry Product Company would be required to perform market
research and determine different parameters that are considered relevant in determination of
the net present value of project (Meyer & Kiymaz, 2015).
Answer to question 5:
Requirement a)
The table below depicts the sensitivity analysis that is computed by making the
assumption that there can be deviation of estimated value by increasing or decreasing 20%.
Under sensitivity analysis, the net present value of project is determined by considering the
changes in the components of cash flow using the cost of capital at the rate of 15%.
Current
Values:
Higher
Discount
Lower
Discount Rate
Higher Net
Cash Flow
Lower Net
Cash Flow

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Rate
Discount
Rate
15% 18% 12% 15% 15%
Year 1 $6,30,000 $6,30,000 $6,30,000 $7,56,000 $5,04,000
Year 2 $6,30,000 $6,30,000 $6,30,000 $7,56,000 $5,04,000
Year 3 $6,60,000 $6,60,000 $6,60,000 $7,92,000 $5,28,000
Year 4 $6,60,000 $6,60,000 $6,60,000 $7,92,000 $5,28,000
Year 5 $6,90,000 $6,90,000 $6,90,000 $8,28,000 $5,52,000
Year 6 $6,90,000 $6,90,000 $6,90,000 $8,28,000 $5,52,000
Year 7 $6,90,000 $6,90,000 $6,90,000 $8,28,000 $5,52,000
Year 8 $5,90,000 $5,90,000 $5,90,000 $7,08,000 $4,72,000
Year 9 $5,90,000 $5,90,000 $5,90,000 $7,08,000 $4,72,000
Year 10 $5,90,000 $5,90,000 $5,90,000 $7,08,000 $4,72,000
NPV $4,32,024 $2,79,214 $6,23,196 $8,15,313 $48,735
The net present value is positive in the given cases. Net present value of project stood
at $ 432024 when the discount rate is 15% and the net present value stood at $ 279214 when
the discount rate is at 18%. On other hand, in all other scenarios, the net present value is
positive at amount of $ 623196 at the rate of 12%, $ 815313 at the lower rate of 15% and
48735 at the rate of 15%. It can be seen that the value of net present value is highest at the
discount rate of 15%.
Requirement b)
The minimum level of annual increased cash flow that is necessary to accept the
project stood at $ 259028.

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Requirement c)
Inflation rate is the external factor that is impacting the valuation of project. It can be
seen from the preparation of cash flow table of the project that inflation is affecting the value
of project. There is increase in value of net present value, payback period and internal rate of
return by the rate of inflation is taken into account. If the inflation rate is considered to be at
3%, it can be seen that the net present value of project has increased to $ 481334, internal rate
of return at 24.01% and the payback period of 2.74.

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Discount Rate 15%
NPV $4,81,334 Positive
Accepte
d
IRR 27.01%
>Discount
Rate
Accepte
d
Payback Period 2.74 < 4 years
Accepte
d
PI 1.37 > 1
Accepte
d
Therefore, from the above computed figures, it can be seen that the value of appraisal
tools have been considerably impacted by the inflation factor. The change in the value is
positive in the sense that net present value generated has increased by considerable amount.
The estimates of revenue and cost are adjusted by considering the changes in inflation value.
Outcome of capital budgeting is affected significantly by inflation factor and the real rate of
return that is incorporated in the computation of the project value is affected by factor such as
inflation. Inflation helps in determination of real cost of capital for the computation of the net
present value, payback period and accounting rate of return (Montinari & Stracca, 2016).
Since the cost of capital does not completely represent the real cost of borrowing the funds,
analysis of capital budgeting is influenced by inflation. However, the result of impact of
capital budget is affected by performing the analysis in a manner that helps in compensating
the inflation. The exposure of requirement of working capital can be reduced during the
inflation as the firms under situation would be under pressure to lower the net working capital
amount by decreasing receivables and inventory.
Answer to question 6:
From the analysis of information provided in the case study and the evaluation of
answers generated from the given questions, it is recommended to Radiant laundry Product
Company to consider making investment in project of Danforth Limited. This is so because
making investment in this particular project is generating positive amount of net present

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value, higher profitability index and lower payback period compared to another project that is
Donnalley limited. Moreover, it can be seen that when considering investment in Danforth
project, company is taking into account the inflation factor. Incorporating the inflation factor
in this particular project, it can be seen that inflation has resulted in generation of higher net
present value and lower payback period that is regarded as feasible factor for analysis.
Furthermore, the profitability index of this particular project is higher as against Donnalley
limited project.
Conclusion:
From the analysis of the given case study, it can be inferred that it would be feasible
for the company to consider making investment in Danforth project. Undertaking this project
would help in generating profit for the business. This is so because it is expected that there
will be increased sales of liquid detergent that would increase the overall profitability of the
business.

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Appendix:

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