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Capital Budgeting Decision Assignment

   

Added on  2020-04-07

7 Pages1967 Words38 Views
Capital BudgetingDecisionRiverlea Limited

Executive SummaryRiverlea Limited is looking at supplying confectionary to Wowcoles for which it will have to expand its capacity by purchasing a new machine. An analysis was carried out for the investment project with the help of capital budgeting techniques specially Net Present Value. Also a sensitivity analysis with respect to the change in expected revenues for both pessimistic and optimistic views was done.The results showed a positive NPV for the base, best and worst scenarios. This means the project is feasible for the company and the company should invest in the machine. Also the semi weak strong EMH was tested for the share price of Riverlea with respect to the change in stock price as a result of the announcement, it was seen that the semi strong form did not exist as the stock prices did not fully reflected the increase in intrinsic value and also the prices increased prior to the announcement.ContentsPart 1.....................................................................................................................................................1Introduction.......................................................................................................................................1Findings.............................................................................................................................................2Conclusion and Recommendations...................................................................................................3Part 2.....................................................................................................................................................4Introduction.......................................................................................................................................4Findings.............................................................................................................................................4Conclusion and Recommendation.....................................................................................................5Bibliography...........................................................................................................................................5

Part 1IntroductionFor a business to undertake a new project, it is important to analyse the risks and returns associated with that investment project. Capital budgeting is a tool that provides for such analysis and helps in ascertaining the economic and financial profitability of any such investments. There are a number of techniques which might be used in the capital budgeting process to provide an analysis of the projects profitability. Some of these techniques include Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index, Payback Period[ CITATION Fab08 \l 16393 ]. However, the most effective of the above is NPV as it gives absolute measure of the profits from the investment.In the current scenario, Riverlea Limited, a public listed company is in the process of negotiation with Wowcoles, a supermarket chain to supply confectionary in a private label forWowcoles. The project is for a period of 10 years and in order to undertake the project, the company will have to undertake a long term investment of purchasing a new machinery to increase its production levels. An analysis of the project was performed taking into account all the incremental revenues andcosts with the help of capital budgeting techniques. Also a sensitivity analysis was conducted to see the effect of lower revenues on the NPV. The findings have been discussed below.FindingsThe NPV of the project was derived taking into account the incremental revenues, variables costs, the decrease in current revenues, decrease in current operating costs, depreciation on the new machinery, the initial investment required and the terminal value of cash flows. Also the payback period, IRR and Profitability index were calculated to confirm the results.The various assumptions taken for the analysis are:The decrease in current revenues is considered as an opportunity cost and is considered a cash outflowThe decrease in current variable costs is considered as a cash inflow

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