Managerial Finance

This report evaluates Dell's investment decision regarding setting up of a new laptop manufacturing plant. It uses various methods like NPV, IRR and payback period to decide whether or not to set-up this plant.

Running Head: Managerial Finance
Managerial Finance
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Managerial Finance
Contents
Executive Summary...................................................................................................................2
Introduction................................................................................................................................3
Capital budgeting decision regarding setting-up a new laptop manufacturing plant.................4
Annual depreciation expenses:...............................................................................................4
Annual cash flows associated with the plant:.........................................................................5
The cash-flows in year-0:.......................................................................................................7
The terminal or year-10 cash flows:.......................................................................................8
The NPV of the project:.........................................................................................................9
The IRR and payback period of the project:........................................................................10
Effect of application of same discount rate to all the projects without considering project
specific risks:........................................................................................................................11
Maximum interest rate on the loan which let the project meets the new financial discipline
requirement:.............................................................................................................................12
Analysis of the new financial discipline requirement:.............................................................13
Conclusions and Recommendations........................................................................................14
References................................................................................................................................15
Appendix A: Excel Spread sheet with detailed calculations....................................................16
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Managerial Finance
Executive Summary
This report evaluates Dell’s investment decision regarding setting up of a new laptop
manufacturing plant. This capital budgeting decision is based on the initial outlay and
subsequent cash flows related to this plant. This report uses various methods like NPV, IRR
and payback period to decide whether or not to set-up this plant. The NPV for this project is
positive and the IRR is higher than the required rate of return so it will be profitable for the
company to set up this plant. This report also analyses the new financial discipline which
requires the company to fund only those projects that generate sufficient cash-flows to pay its
financing cost every year.
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Managerial Finance
Introduction
Dell is a US-based multinational company. It is one of the largest providers of computer
technology and related products and services, employing approximately 157,000 peoples
around the world (Dell annual report, 2019).
Dell is considering setting up a new laptop manufacturing plant which requires an initial
investment of $500 million. This document uses various methods like NPV, IRR and payback
period to decide whether or not to set-up this plant.
This report includes a discussion about the pros and cons of a new financial requirement
which forces the company to fund only those projects that generate sufficient cash-flows to
pay the financing cost every year. This discussion also involves the calculation of the
maximum interest rate on the loan which let this project meets the financial discipline
requirement.
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Managerial Finance
Capital budgeting decision regarding setting-up a new laptop
manufacturing plant
Annual depreciation expenses:
Depreciation
Schedule
Starting of period
value
Annual
Depreciation
Ending of period
value
Year 1 $50,00,00,000 $5,00,00,000 $45,00,00,000
Year 2 $45,00,00,000 $4,50,00,000 $40,50,00,000
Year 3 $40,50,00,000 $4,05,00,000 $36,45,00,000
Year 4 $36,45,00,000 $3,64,50,000 $32,80,50,000
Year 5 $32,80,50,000 $3,28,05,000 $29,52,45,000
Year 6 $29,52,45,000 $2,95,24,500 $26,57,20,500
Year 7 $26,57,20,500 $2,65,72,050 $23,91,48,450
Year 8 $23,91,48,450 $2,39,14,845 $21,52,33,605
Year 9 $21,52,33,605 $2,15,23,361 $19,37,10,245
Year 10 $19,37,10,245 $1,93,71,024 $17,43,39,220
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Managerial Finance
Annual cash flows associated with the plant:
Time-line ( Annual
cash inflows and
outflows)
Yea
r 1
Yea
r 2
Yea
r 3
Yea
r 4
Yea
r 5
Yea
r 6
Yea
r 7
Yea
r 8
Yea
r 9
Yea
r 10
Laptops sold (2%
increase every year)
500
000
510
000
520
200
530
604
541
216
552
040
563
081
574
343
585
830
597
546
Revenues (laptops
sold * Price per
laptop)
$35,
00,0
0,00
0
$35,
70,0
0,00
0
$36,
41,4
0,00
0
$37,
14,2
2,80
0
$37,
88,5
1,25
6
$38,
64,2
8,28
1
$39,
41,5
6,84
7
$40,
20,3
9,98
4
$41,
00,8
0,78
3
$41,
82,8
2,39
9
Variable
cost( laptops sold *
variable cost per
laptop) (outflow)
$7,0
0,00
,000
$7,1
4,00
,000
$7,2
8,28
,000
$7,4
2,84
,560
$7,5
7,70
,251
$7,7
2,85
,656
$7,8
8,31
,369
$8,0
4,07
,997
$8,2
0,16
,157
$8,3
6,56
,480
Fixed cost (outflow)
$2,5
0,00
,000
$2,5
0,00
,000
$2,5
0,00
,000
$2,5
0,00
,000
$2,5
0,00
,000
$2,5
0,00
,000
$2,5
0,00
,000
$2,5
0,00
,000
$2,5
0,00
,000
$2,5
0,00
,000
Depreciation
(outflow)
$5,0
0,00
,000
$4,5
0,00
,000
$4,0
5,00
,000
$3,6
4,50
,000
$3,2
8,05
,000
$2,9
5,24
,500
$2,6
5,72
,050
$2,3
9,14
,845
$2,1
5,23
,361
$1,9
3,71
,024
Annual cash flows
before tax
$20,
50,0
0,00
0
$21,
56,0
0,00
0
$22,
58,1
2,00
0
$23,
56,8
8,24
0
$24,
52,7
6,00
5
$25,
46,1
8,12
5
$26,
37,5
3,42
7
$27,
27,1
7,14
2
$28,
15,4
1,26
6
$29,
02,5
4,89
5
Tax expense (45%)
(outflow)
$9,2
2,50
,000
$9,7
0,20
,000
$10,
16,1
5,40
0
$10,
60,5
9,70
8
$11,
03,7
4,20
2
$11,
45,7
8,15
6
$11,
86,8
9,04
2
$12,
27,2
2,71
4
$12,
66,9
3,57
0
$13,
06,1
4,70
3
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Managerial Finance
Net annual cash
flows
$11,
27,5
0,00
0
$11,
85,8
0,00
0
$12,
41,9
6,60
0
$12,
96,2
8,53
2
$13,
49,0
1,80
3
$14,
00,3
9,96
9
$14,
50,6
4,38
5
$14,
99,9
4,42
8
$15,
48,4
7,69
6
$15,
96,4
0,19
2
The cash-flows in year-0:
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Managerial Finance
Starting Investment (Plant investment + inventory
investment) (outflow) $60,00,00,000
The terminal or year-10 cash flows:
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Managerial Finance
Annual cash flows for year 10 $29,02,54,895
Terminal value of the plant at end of year 10 $15,00,00,000
Recovered amount from the inventory investment at end of year
10 $10,00,00,000
Total year 10 cash flows $54,02,54,895
The NPV of the project:
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Managerial Finance
Year
0
Year
1
Year
2
Year
3
Year
4
Year
5
Year
6
Year
7
Year
8
Year
9
Year
10
Cash
flows
-
$60,
00,0
0,00
0
$11,
27,5
0,00
0
$11,
85,8
0,00
0
$12,
41,9
6,60
0
$12,
96,2
8,53
2
$13,
49,0
1,80
3
$14,
00,3
9,96
9
$14,
50,6
4,38
5
$14,
99,9
4,42
8
$15,
48,4
7,69
6
$54,
02,5
4,89
5
NPV $10,21,15,791
The net present value for this project is positive, $102115791. It tells that the present value of
the total cash inflows is greater than the present value of total cash outflows. Hence, going by
NPV rule the company should go ahead with this plant (Gallo, 2014).
The IRR and payback period of the project:
9
IRR 20%

Managerial Finance
The IRR of 20% is higher than the required return of 16%. So, it will be profitable to set up
this plant going by the internal rate of return rule (Gallo, 2016).
Payback period 4.85 years
The payback period of 4.85 tells that it will take 4.85 years for this plant to recover the initial
investment amount (or to reach breakeven). This breakeven point can be compared with the
company's target time-period to recover initial outlay if the payback period is shorter than
this target then the company should set up this plant.
Effect of application of the same discount rate to all the projects without
considering project-specific risks:
It makes more sense to adjust the discount rate according to the project specific risk. For
example, if any project is riskier, then its discount rate factor should be increased. Such
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Managerial Finance
discount rate adjustment will result in the reduced present value of the project's future cash
flows indicating the increased uncertainty related to the project.
The maximum interest rate on the loan which let the project
meets the new financial discipline requirement
Cash flows:
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Managerial Finance
Year 1 112750000
Year 2 118580000
Year 3 124196600
Year 4 129628532
Year 5 134901803
Year 6 140039969
Year 7 145064385
Year 8 149994428
Year 9 154847696
Year 10 540254895
Minimum cash flow from the project in 10
year time period $11,27,50,000
Total initial outlay $60,00,00,000
Time-period (years) 10
Maximum EMI that could be paid by this
project $11,27,50,000
Maximum interest rate on loan to meet
the financial discipline requirement 13%
Analysis of the new financial discipline requirement
The new requirement is that only those projects will be funded that generate sufficient cash-
flows to pay the financing cost every year. This requirement will allow the company to avoid
any liquidity issues in the future as each project will be able to pay its annual financing cost.
The downside to this requirement is that the company can miss profitable
opportunities/projects that have highly variable cash flows. As such projects might not be
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Managerial Finance
able to meet its financing cost every year but overall they can be beneficial for the firm
according to the NPV/IRR rule.
Conclusions and Recommendations
This report evaluated Dell’s decision to set up a new laptop manufacturing plant with an
initial investment of $500 million. The cash flows from this project have been analysed to
calculate the NPV, IRR and Payback period. The NPV for this project is a positive value
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Managerial Finance
($10,21,15,791). The project’s IRR of 20% is greater than the required return of 16%. So, it
will be profitable to set up this plant according to both NPV and IRR rule.
This report analysed the new financial requirement which forces the company to fund only
those projects that generate sufficient cash-flows to pay the financing cost every year. The
maximum interest rate on the loan which let this project meets the financial discipline
requirement is 13%. The advantage of this requirement is that it will allow the company to
avoid any liquidity issues in the future. But the downside is that the company can miss
profitable opportunities/projects that have highly variable cash flows.
References
DELL (2019). Dell Technologies Inc. Annual Report. Available 18 April 2019:
https://www.google.com/url?
sa=t&rct=j&q=&esrc=s&source=web&cd=23&ved=2ahUKEwiGsd7mptnhAhUWEnIKHV
m3A60QFjAWegQIBBAC&url=http%3A%2F%2Fwww.annualreports.com%2FClick
%2F24655&usg=AOvVaw1HF9NsXSPPOwCIkD8Aqm6O
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Managerial Finance
Gallo, A. (2014). A Refresher on Net Present Value. Harvard Business Review. Available 18
April 2019: https://hbr.org/2014/11/a-refresher-on-net-present-value
Gallo, A. (2016). A Refresher on Internal Rate of Return. Harvard Business Review.
Available 18 April 2019: https://hbr.org/2016/03/a-refresher-on-internal-rate-of-return
Appendix A: Excel Spread sheet with detailed calculations
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