Evaluation of New Proposal by Pinto Ltd. - Financial Analysis

The memo evaluates the new proposal by Pinto Ltd. using various capital budgeting tools. The base case analysis shows that the project will generate profits and should be accepted. Sensitivity and scenario analysis are also conducted to incorporate uncertainty. The report concludes that the project should be accepted.

Subject: Finance
University: Southern Cross University
Student Name: SYED MUZZAMMIL AHMED
Student ID: 22934738

To: CEO, Pinto Limited
From: SYED AHMED
Date: 20TH MAY, 2018
Subject : Recommendation on the new project
In our memo, we have discussed the evaluation of the new proposal put forward by Pinto ltd.
using various financial tools we have analyzed the given data and tried to comment on the
financial acceptability of the new proposal.
Base case analysis:
The base analysis represents the direct analysis of the collected data. We have calculated few
capital budgeting metrics of the said proposal and commentated on the same.
Particulars Result Comment
Net present
value
$5,605,816 Net present value is the value of the future money discounted
at a required rate of return to calculate the worth of money
today. (Bierman & Smidt, 2010) In other words, net present
value sums up the net value of cash flows expected to be
generated. If the sums of these cash flows are positive then the
project is expected to generate profits and should be opted for.
The new proposal of the company is expected to create
positive value addition to the company.
Profitability
Index
1.31 times Profitability index is the ratio which helps to calculate the
payoff from a given project. (Adelaja, 2015)This ratio helps to
quantify the amount of value added per unit of investment
made. If the profitability index is more than one, then the
project is to create value and should be opted for. For the
given proposal the profitability index is 1.31 times. This
indicates that the project will generate profits.
Internal Rate
of return
21.14% Internal rate of return is the capital budgeting tool that helps
quantify the expected rate of return from a potential
investment (Dayananda, Irons, Harrison, Herbohn, &
Rowland, 2008). If this rate is higher than the required rate of

return then the new investment should be opted for. For the
given proposal the internal rate of return is 21.14% when the
required rate is 10%. Hence the project is likely to earn more
than the cast and should be accepted.
Pay-back
period
2.73 years Pay-back period refers to the time period required by a project
to recover its initial invested amount (Peterson & Fabozzi,
2012). Lower the pay-back period, more time is viable for the
company to earn profits. For the given case the project period
is 5 years and the pay-back period is 2.73 years, this means
that any cash earned by the company after this point will be
profit. Therefore, the project is likely to earn high profits and
should be accepted.
Discounted
payback
period
3.38 years Discounted pay-back period is same as a pay-back period. It is
a litter higher than a normal pay-back period as it uses
discounted values of cash flows to determine the investment
recoverable time. (Piper, 2015) The discounted payback
period for the given proposal is 3.38 years, which seems
appropriate and hence the proposal should have opted for
execution.
Uncertainty analysis:
The capital budgeting tools are a very vital financial tool which helps the investor take
decisions regarding the acceptance or rejection of new investment opportunities. But the use
of this capital budgeting technique may lead to uncertain results (Rivenbark, Vogt, &
Marlowe, 2009). The inputs collected for the investment appraisal are based on market
research and assumptions. Change in the market structure or any of the assumptions may lead
o a different result. Taking this factor of uncertainty into account there may be possible
conclusions. Setting up the future requirements is not an easy task. Therefore, though the
capital budgeting techniques may be very useful in decision making, they will always be a
factor of uncertainty involved until the actual results are obtained.

Sensitivity Analysis:
Sensitivity analysis is the part of capital budgeting technique that helps us incorporate the
factor of uncertainty in the results. (Seitz & Ellison, 2009) This system helps the investor
evaluate the effect on the outcomes of the proposal if changes in any input assumptions are
made. This will help us find out the sensitivity of the output with respect to the input.
Metric Conclusion
Discount rate From the graph below we can see that the outcomes of the project are lightly
sensitive to the discount rate. The discount rate used differs from project to
project and is based on the cost. There might be changes in the rate of return
based on the requirements of the investors.
Units sold The outcomes of the proposal are highly sensitive to the changes in units
sold. Even if there are little variances in the number of units sold then the
outcome of the project will be highly affected.
Networking
capital
The outcome of the project is least sensitive to changes in the working
capital requirements. This may be so because changes in working capital
will only affect the cash flows initially and not affect the cash flows for the
other years.
-20% -10% 0% 10% 20%
$0
$2,000,000
$4,000,000
$6,000,000
$8,000,000
$10,000,000
$12,000,000
WACC
Units sold yr1
NWC% yr1 rev
Scenario analysis
Scenario analysis is one of another capital budgeting tools that help us evaluate the big
picture with uncertainties in them (Shapiro, 2007). Scenario analysis helps the investor have
various views on the outcomes of the project based on various assumptions. Any of the

scenarios may turn up to be the real picture. Therefore the investor needs to take their
decision only after considering all the assumptions:
Scenario Rate of
return
Units
Sold
NPV Remarks
Optimist 8% 220000 $9102232 This is the scenario in which is likely to occur
only if all the assumptions hold true. This
scenario depicts the best outcome of the
project.
Realist 10% 200000 $5605816 This scenario is likely to occur only when few
of the assumptions hold true. This is the most
likely to occur situation with very low chances
of variances.
Pessimis
t
12% 180000 $2460100 This is the scenario which is likely to occur
only when most of the assumptions fail to hold
true.
Conclusion and Recommendation
The analysis of the above cash flows from the market research by the company has provided
us with the basis for conducting capital budgeting analysis. Based on which we can see that
the project will be earning the company profits. The returns generated will be higher than the
costs. Hence the project should be accepted.

Bibliography
Adelaja, T. (2015). Capital Budgeting: Investment Appraisal Techniques Under Certainty.
Chicago: CreateSpace Independent Publishing Platform.
Bierman, H., & Smidt, S. (2010). The Capital Budgeting Decision. Boston: Routledge.
Dayananda, D., Irons, R., Harrison, S., Herbohn, J., & Rowland, P. (2008). Capital
Budgeting: Financial Appraisal of Investment Projects. Cambridge: Cambridge University
Press.
Peterson, P. P., & Fabozzi, F. J. (2012). Capital Budgeting. New York, NY: Wiley.
Piper, M. (2015). Accounting made simple. United States: CreateSpace Pub.
Rivenbark, W. C., Vogt, J., & Marlowe, J. (2009). Capital Budgeting and Finance: A Guide
for Local Governments. Washington, D.C.: ICMA Press.
Seitz, N., & Ellison, M. (2009). Capital Budgeting and Long-Term Financing Decisions.
New York: Thomson Learning.
Shapiro, A. C. (2007). Capital Budgeting and Investment Analysis. New Jersey: Wiley.

Appendix:
Base Case Analysis:
income tax rate 30%
Discount rate 10%
NWC % of year 1 revenue 20%
inflation 3%
Sales data 0 1 2 3 4 5
Sales price per unit $75.00 $77.25 $79.57 $81.95 $84.41
Unit sales 2,00,000 3,00,000 4,50,000 2,25,000 1,12,500
Cost data (excluding depreciation) 0 1 2 3 4 5
Cost per unit $45.00 $46.35 $47.74 $49.17 $50.65
Net income 0 1 2 3 4 5
Revenues $150,00,000 $231,75,000 $358,05,375 $184,39,768 $94,96,481
– Costs $90,00,000 $139,05,000 $214,83,225 $110,63,861 $56,97,888
– Selling, general and administrative
costs $10,00,000 $10,50,000 $11,02,500 $11,57,625 $12,15,506
– Opportunity cost- rent lost $2,50,000 $2,50,000 $2,50,000 $2,50,000 $2,50,000
– Depreciation expense $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
taxable income $17,50,000 $49,70,000 $99,69,650 $29,68,282 -$6,66,914
– Taxes $5,25,000 $14,91,000 $29,90,895 $8,90,485 -$2,00,074
After-Tax income $12,25,000 $34,79,000 $69,78,755 $20,77,798 -$4,66,840
Annual Net Cash Flow estimates 0 1 2 3 4 5
Investment in fixed assets -$150,00,000 $15,000
CF due to change in net working capital -$30,00,000 $30,00,000
Net income $0 $12,25,000 $34,79,000 $69,78,755 $20,77,798 -$4,66,840
Add back Depreciation $0 $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
Net cash Flows -$180,00,000 $42,25,000 $64,79,000 $99,78,755 $50,77,798 $55,48,160

Year 0 1 2 3 4 5
Net cash flows ($ millions) ($180,00,000) $42,25,000 $64,79,000 $99,78,755 $50,77,798 $55,48,160
Cumulative cash flows ($180,00,000) ($137,75,000) ($72,96,000) $26,82,755 $77,60,553 $133,08,713
Discounted cash flow (PV) ($180,00,000) $38,40,909 $53,54,545 $74,97,186 $34,68,204 $34,44,971
Cumulative discounted cash flow ($180,00,000) ($141,59,091) ($88,04,545) ($13,07,359) $21,60,845 $56,05,816
Payback period 2.73 years
discounted Payback period 3.38 years
Profitability index 1.31 times
Net Present Value (NPV) (in thousands) $56,05,816
IRR 21.14%

Sensitivity Analysis:
Income tax rate 30%
Discount rate 10%
NWC % of year 1 revenue 20%
Inflation 3%
Sales data 0 1 2 3 4 5
Sales price per unit $75.00 $77.25 $79.57 $81.95 $84.41
Unit sales 2,00,000 3,00,000 4,50,000 2,25,000 1,12,500
Cost data (excluding depreciation) 0 1 2 3 4 5
Cost per unit $45.00 $46.35 $47.74 $49.17 $50.65
Net income 0 1 2 3 4 5
Revenues $150,00,000 $231,75,000 $358,05,375 $184,39,768 $94,96,481
– Costs $90,00,000 $139,05,000 $214,83,225 $110,63,861 $56,97,888
– Selling, general and administrative
cost $10,00,000 $10,50,000 $11,02,500 $11,57,625 $12,15,506
– Opportunity cost- rent lost $2,50,000 $2,50,000 $2,50,000 $2,50,000 $2,50,000
– Depreciation expense $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
Taxable income $17,50,000 $49,70,000 $99,69,650 $29,68,282 -$6,66,914
– Taxes $5,25,000 $14,91,000 $29,90,895 $8,90,485 -$2,00,074
After-tax income $12,25,000 $34,79,000 $69,78,755 $20,77,798 -$4,66,840
Annual Net Cash Flow Estimates 0 1 2 3 4 5
Investment in fixed assets -$150,00,000 $15,000
CF due to change in net working capital -$30,00,000 $30,00,000
Net income $0 $12,25,000 $34,79,000 $69,78,755 $20,77,798 -$4,66,840
Add back depreciation $0 $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
Net cash flows -$180,00,000 $42,25,000 $64,79,000 $99,78,755 $50,77,798 $55,48,160
NPV $56,05,816

Sensitivity analysis
NPV NPV NPV
% deviation from base case WACC $56,05,815.90 Units sold yr1 $56,05,815.90 NWC% yr1 rev $56,05,815.90
-30% 7.0% $75,82,833.17 140000 -$6,20,262.77 14.0% $59,46,986.71
-15% 8.5% $65,63,864.81 170000 $24,92,776.57 17.0% $57,76,401.31
0% 10.0% $56,05,815.90 200000 $56,05,815.90 20.0% $56,05,815.90
15% 11.5% $47,04,049.84 230000 $87,18,855.24 23.0% $54,35,230.50
30% 13.0% $38,54,350.60 260000 $118,31,894.57 26.0% $52,64,645.09
Sensitivity calculation
WRT WACC WRT UNITS WRT NWC
-
35.27 111.06
-
6.09
-
17.09 55.53
-
3.04
- - -
16.09
-
55.53 3.04
31.24
-
111.06 6.09
-30% -15% 0% 15% 30%
-$2,000,000
$0
$2,000,000
$4,000,000
$6,000,000
$8,000,000
$10,000,000
$12,000,000
$14,000,000
WACC
Units sold yr1
NWC% yr1 rev

Scenario Analysis:
Scenario 1
Income tax rate 30%
Discount rate 8%
NWC % of year 1 revenue 20%
Inflation 3%
Sales data 0 1 2 3 4 5
Sales price per unit $75.00 $77.25 $79.57 $81.95 $84.41
Unit sales 2,20,000 3,30,000 4,95,000 2,47,500 1,23,750
Cost data (excluding depreciation) 0 1 2 3 4 5
Cost per unit $45.00 $46.35 $47.74 $49.17 $50.65
Net income 0 1 2 3 4 5
Revenues $165,00,000 $254,92,500 $393,85,913 $202,83,745 $104,46,129
– Costs $99,00,000 $152,95,500 $236,31,548 $121,70,247 $62,67,677
– Selling, general and administrative cost $10,00,000 $10,50,000 $11,02,500 $11,57,625 $12,15,506
– Opportunity cost- rent lost $2,50,000 $2,50,000 $2,50,000 $2,50,000 $2,50,000
– Depreciation expense $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
Taxable income $23,50,000 $58,97,000 $114,01,865 $37,05,873 -$2,87,055
– Taxes $7,05,000 $17,69,100 $34,20,560 $11,11,762 -$86,116
After-tax income $16,45,000 $41,27,900 $79,81,306 $25,94,111 -$2,00,938
Annual Net Cash Flow Estimates 0 1 2 3 4 5
Investment in fixed Assets -$150,00,000 $15,000
CF due to change in net working-capital -$33,00,000 $33,00,000
Net income $0 $16,45,000 $41,27,900 $79,81,306 $25,94,111 -$2,00,938
Add back Depreciation $0 $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
Net cash Flows -$183,00,000 $46,45,000 $71,27,900 $109,81,306 $55,94,111 $61,14,062

Year 0 1 2 3 4 5
Net Cash Flows ($ millions) ($183,00,000) $46,45,000 $71,27,900 $109,81,306 $55,94,111 $61,14,062
Cumulative Cash Flows ($183,00,000) ($136,55,000) ($65,27,100) $44,54,206 $100,48,317 $161,62,378
Discounted cash flow (PV) ($183,00,000) $43,00,926 $61,11,025 $87,17,314 $41,11,839 $41,61,128
Cumulative discounted Cash flow ($183,00,000) ($139,99,074) ($78,88,049) $8,29,266 $49,41,104 $91,02,232
Payback period 2.59 years
Discounted Payback period 2.80 years
Profitability Index 1.50 times
Net Present Value (NPV) (in
thousands) $91,02,232
IRR 24.73%
Scenario 2:
Income tax rate 30%
Discount rate 10%
NWC % of year 1 revenue 20%
Inflation 3%
Sales data 0 1 2 3 4 5
Sales price per unit $75.00 $77.25 $79.57 $81.95 $84.41
Unit sales 2,00,000 3,00,000 4,50,000 2,25,000 1,12,500
Cost data (excluding depreciation) 0 1 2 3 4 5
Cost per unit $45.00 $46.35 $47.74 $49.17 $50.65
Net income 0 1 2 3 4 5
Revenues $150,00,000 $231,75,000 $358,05,375 $184,39,768 $94,96,481
– Costs $90,00,000 $139,05,000 $214,83,225 $110,63,861 $56,97,888
– Selling, general and administrative cost $10,00,000 $10,50,000 $11,02,500 $11,57,625 $12,15,506
– Opportunity cost- rent lost $2,50,000 $2,50,000 $2,50,000 $2,50,000 $2,50,000

– Depreciation expense $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
Taxable income $17,50,000 $49,70,000 $99,69,650 $29,68,282 -$6,66,914
– Taxes $5,25,000 $14,91,000 $29,90,895 $8,90,485 -$2,00,074
After-tax income $12,25,000 $34,79,000 $69,78,755 $20,77,798 -$4,66,840
Annual Net Cash Flow Estimates 0 1 2 3 4 5
Investment in fixed Assets -$150,00,000 $15,000
CF due to change in net working capital -$30,00,000 $30,00,000
Net income $0 $12,25,000 $34,79,000 $69,78,755 $20,77,798 -$4,66,840
Add back Depreciation $0 $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
Net cash flows -$180,00,000 $42,25,000 $64,79,000 $99,78,755 $50,77,798 $55,48,160
Year 0 1 2 3 4 5
Net cash flows ($ millions) ($180,00,000) $42,25,000 $64,79,000 $99,78,755 $50,77,798 $55,48,160
Cumulative cash flows ($180,00,000) ($137,75,000) ($72,96,000) $26,82,755 $77,60,553 $133,08,713
Discounted cash flow (PV) ($180,00,000) $38,40,909 $53,54,545 $74,97,186 $34,68,204 $34,44,971
Cumulative discounted cash flow ($180,00,000) ($141,59,091) ($88,04,545) ($13,07,359) $21,60,845 $56,05,816
Payback period 2.73 years
Discounted payback period 3.38 years
Profitability index 1.31 times
Net Present Value (NPV) (in thousands) $56,05,816
IRR 21.14%

Scenario 3:
Income tax rate 30%
Discount rate 12%
NWC % of year 1 revenue 20%
Inflation 3%
Sales data 0 1 2 3 4 5
Sales price per unit $75.00 $77.25 $79.57 $81.95 $84.41
Unit sales 1,80,000 2,70,000 4,05,000 2,02,500 1,01,250
Cost data (excluding depreciation) 0 1 2 3 4 5
Cost per unit $45.00 $46.35 $47.74 $49.17 $50.65
Net income 0 1 2 3 4 5
Revenues $135,00,000 $208,57,500 $322,24,838 $165,95,791 $85,46,833
– Costs $81,00,000 $125,14,500 $193,34,903 $99,57,475 $51,28,100
– Selling, general and Administrative Cost $10,00,000 $10,50,000 $11,02,500 $11,57,625 $12,15,506
– Opportunity cost- rent lost $2,50,000 $2,50,000 $2,50,000 $2,50,000 $2,50,000
– Depreciation Expense $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
Taxable income $11,50,000 $40,43,000 $85,37,435 $22,30,692 -$10,46,773
– Taxes $3,45,000 $12,12,900 $25,61,231 $6,69,207 -$3,14,032
After-tax income $8,05,000 $28,30,100 $59,76,205 $15,61,484 -$7,32,741
Annual Net Cash Flow Estimates 0 1 2 3 4 5
Investment in fixed assets -$150,00,000 $15,000
CF due to change in net working capital -$27,00,000 $27,00,000
Net income $0 $8,05,000 $28,30,100 $59,76,205 $15,61,484 -$7,32,741
Add back Depreciation $0 $30,00,000 $30,00,000 $30,00,000 $30,00,000 $30,00,000
Net cash FLOW -$177,00,000 $38,05,000 $58,30,100 $89,76,205 $45,61,484 $49,82,259

Year 0 1 2 3 4 5
Net cash flows ($ millions) ($177,00,000) $38,05,000 $58,30,100 $89,76,205 $45,61,484 $49,82,259
Cumulative Cash flows ($177,00,000) ($138,95,000) ($80,64,900) $9,11,305 $54,72,789 $104,55,047
Discounted Cash flow (PV) ($177,00,000) $33,97,321 $46,47,720 $63,89,085 $28,98,906 $28,27,067
Cumulative discounted cash flow ($177,00,000) ($143,02,679) ($96,54,959) ($32,65,873) ($3,66,968) $24,60,100
Payback period 2.90 years
Discounted Payback period 4.13 years
Profitability index 1.14 times
Net Present Value (NPV) (in thousands) $24,60,100
IRR 17.29%