Financial Feasibility of Proposed Wind Turbines and Sail Boats Projects

Memorandum
To: Cathy Petty, Vice-President Marketing
From: Dave Pawluk, Team Leader
Subject: Financial Feasibility of Proposed Wind Turbines and Sail Boats Projects
Date: March 25, 2018
Introduction
The assignment aims at analyzing the expansion plan of CAPELLA Industries Ltd which is
engaged in manufacture of high-end inflatable boats and boat motors and the company has been operating
in Canada for more than 35 years. The company wants to expand its business further and has two product
options which are investments in Wind turbines and the other one is Sail Boats. The management of the
company is of the opinion that both the projects are costly and will be requiring a new manufacturing
plant.
Cost of Capital
Cost of capital refers to the opportunity cost which is related to any specific investment. It
signifies what return could have been earned by the investor if he had invested elsewhere with the same
level of risk (1). In the case of CAPELLA Industries, the cost of capital analysis is conducted for both the
projects which the management has in mind for investment purposes. In the case of sails boat project, the
company has already prior experience in dealing with similar manufacturing activities and therefore for
the purpose of computing Beta (B) the stock index, market share price, stock return of CAPELLA
Industries are used (3). The beta which is computed in case of Sail boat is shown at 1.320. The cost of
equity of the project as calculated is 9.44% which is more than the market return expected. For the
purpose of calculating Cost of equity, Capital Asset Pricing Model (CAPM) is adopted as it is considered
to give the most accurate results. Similarly, the cost of debt which has been calculated for Sail boat
project is 6.82%. The cost of debt is calculated by using the coupon rate and tax rate on the debt. The
weighted average cost of capital in case of Sail boat projects as calculated is 7.19%.
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In case of Wind Turbine project, the company will be investing in the project where the company
does not have any prior experience of the market and is diversifying for the first time. The company
therefore in order to calculate the Cost of equity of the projects is considering the cost of equity of similar
industries engaged in Wind turbine manufacture and the average cost of equity of five industries are
assumed to be the cost of equity of CAPELLA Industries. For the purpose of computing cost of equity
CAPM method is used. The cost of equity is shown at 9.67%. The cost of debt is shown at 6.82%. The
weighted average cost of capital for the wind turbine project is shown at 7.58%. The weighted average
cost of capital in case of wind turbine project is more which signifies more risks associated with the
project.
Capital Budgeting
Net Present Value (NPV) analysis show the difference between the present value of the cash
inflows deducted by the present value of the cash out flows of the company. The net present value
analysis is very useful for analyzing the worth of investing in a project. In other words, it is used to
determine the cash which can be generated if the investor invests in the project. In the case of CAPELLA
Industries, the NPV analysis is conducted considering 20 years of applying capital budgeting techniques
(2). The net present value of project Sail boats is shown to be positive and shows a figure of $
1616,80,927 which signifies that the project has the potential to be earn profits if investment is made in
the same. In case of Wind turbine project, the net present value of the project is shown at $ 2008,74,036
which is calculated in the same way considering 20 years of net cash inflows. The Wind turbine project
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has better net present value as compared to Sail boat project. This also shows that the Wind turbine
project is also viable for investment purposes as per the decisions of the management of the company (4).
Recommendations
As per the analysis of the Net Present Value (NPV) both the projects which the company plans to
undertake in order to expand its business looks promising. However, the costs which are associated with
the projects are high. NPV of the both the projects show positive values which means that the company
will be able to generate decent future cash earnings if the business can invest in any of the two projects
which the company has planned to undertake (5). Therefore, the company can undertake investments in
both the projects if sufficient amount of cash is available. However, if the management of CAPELLA
Industries wants to invest in any one of the projects then it must invest in Wind turbine project as the cash
generated as per NPV analysis is more than the cash generated in Sails boat project (6).
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Reference
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Accounting and Economics. 2013 Apr 1;55(2-3):206-24.
2. Burns R, Walker J. Capital budgeting surveys: the future is now.
3. Cucchiella F, D’Adamo I, Gastaldi M. Financial analysis for investment and policy decisions in
the renewable energy sector. Clean Technologies and Environmental Policy. 2015 Apr
1;17(4):887-904.
4. Grob HL. Capital budgeting with financial plans: an introduction. Springer-Verlag; 2013 Oct 5.
5. Jain N, Singh SN, Srivastava SC. A generalized approach for DG planning and viability analysis
under market scenario. IEEE Transactions on Industrial Electronics. 2013 Nov;60(11):5075-85.
6. Kim JB, Sohn BC. Real earnings management and cost of capital. Journal of Accounting and
Public Policy. 2013 Nov 1;32(6):518-43.
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