Investment Projects considering PHONE : Report

Added on - 22 Jul 2020

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FINANCE
Table of ContentsExecutive Summary.........................................................................................................................3INTRODUCTION..........................................................................................................................4a) Calculation of Weighted Average Cost of Capital(WACC) for PHONE...............................4b) Incremental cash flow tables for Proposal A and B................................................................5c) Base-case scenario's and calculation of NPVs and IRRs........................................................6d) Impact of unequal lives for Options A and B.........................................................................7e) Sensitivity Analysis of both the projects A and B..................................................................8f) Break Even Analysis for sales price, sale units and variable cost:..........................................8g) Decision on whether it should be lease or not........................................................................9Recommendations:.........................................................................................................................10REFERENCES..............................................................................................................................11
Executive SummaryThis report gives an analysis and comparison of two investment projects with aim ofdeciding the most beneficial option, considering PHONE's project A has 10 years remaininguseful lifetime.Specially, the options analysed were whether PHONE should select the option A orOption B, methods of analysis include break-even point, sensitivity, WACC and NPV.It was found that option of Project A offers an NPV of $2266945.4which is much higherthan Project B in long term. The IRR of project B is119%which is much higher than project A.When considering the Replacement method for unequal life, project B's has a NPV of$2688561.92which is higher than project A.Based on these findings, it is recommended that PHONE should purchase old machinefor its remaining 4 years of useful lifetime as it is not sure about the success of new productwhich is silicon cover for Iphones. The option of leasing should not be pursued at this initialstage of launching a product as it is not sure about its success.Thus it is recommended to stay with project B, to avoid the risk of high loss in money,after the failure of the project. As in pessimistic analyses its clearly given that any decrease in itsexpected sales and units can impact the PHONE into negative cash flows. So purchasing the oldmachine can help the company to avoid such risks. Because in second option or in project B, theinitial investment is only $470000 which is lesser than project A.
INTRODUCTIONPHONE is popular for its Iphone covers and it already got big hit in its sales which isaround 3 Millions. It is earning good profits which is $1 Million, so overall PHONE is in goodposition. But still it wants to expand its business through launching new product which is Siliconcover for Iphone. But this new product is costlier than previous one. In this case study severalrisk analyses, sensitivity analyses and break-even analyses has been done to give proper reasonand evidences behind any recommendations. In this case study PHONE has two choices toproduce its new product which is silicon cover: whether to purchase new machine which has acost around $935000 with a 10 years of life span. This project has named project A on the otherhand the other alternative available is to purchase old machinery at less price $470000 but its lifespan is only 4 years. This project has named project B. In this case study, it is explained anddiscussed well about which project is beneficial for PHONE.a) Calculation of Weighted Average Cost of Capital(WACC) for PHONEWACC –Weighted average cost of capital is the average rate of return which a investorexpects from the company in which it has invested (Brealey and Mohanty, 2012). The weightsare the fraction of rate of returns on the basis of each financing source such as equity and debt.WACC = ((E/V)*Re)+[((D/V)*Rd)*(1-T)]E= Market value of the company's equity= $8 MillionD= Market value of the company's debt = $2 MillionV= Total market value of the company(E+D) = $10 MillionRe= Cost of Equity = 14%Rd= Cost of Debt = 9%T= Tax Rate = 27.5%Hence the calculations are as follows:WACC =((8/10)*.14)+[((2/10)*.9)*(1-.275)]= 0.2425 or 24.25%So, PHONE's weighted average cost of capital is 24.25%, this means that for every $1 fundraises by PHONE from investors, it must pay $0.24 in return annually. Which is equivalent to$0.2 monthly.
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