RRT Project: Project Evaluation

This study evaluates the Auditizz Electronics' RRT investment project using discounted cash flow (DCF) valuation technique. It includes non-discounted payback period, net accounting rate of return, NPV and IRR of the project, sensitivity analysis, forecasting risk and risk management, investment decision, and impact of a positive NPV investment project on the market value of the Corporation.

RRT Project 1
RRT Project: Project Evaluation
by Student Name
Class & Course
Professor
University
The City & State
Date

RRT Project 2
Discounted Cash Flow (DCF) method of asset valuation
Discounted Cash Flow (DCF) method is a valuation technique used to determine the present
value of an investment project using its future cash flows. As the name dictates, the present value
of future cash flows is calculated using discount rates. The objective of DCF is to determine the
amount an investor would receive today after investing in a project that is expected to yield
returns in the future. DCF is made of the time value of any technique: A dollar today has more
value than a dollar tomorrow. Investors use DCF to decide whether or not to invest in a project. A
project is accepted when the DCF is higher than the initial cash outflow. On the other hand, a
project is rejected when the DCF is lower than the initial cash outflow (Baker & Martin, 2011, p.
56).
Some of the discounted cash flow valuation methods used to evaluate future projects are Net
Present Value (NPV) and Internal Rate of Return (IRR). Besides the DCF methods, investors also
rely on Payback Period (PBP) and Accounting Rate of Return (ARR). This study seeks to
calculate the present value of the future cash flows that would be received by the Auditizz
Electronics for investing in the ‘real-time translator’ (RTT) project (English, 2011, p. 87).
1) The non-discounted payback period (PBP) of the project
Non-discounted payback period technique does not consider the time value of money. The PBP
assumes that a dollar tomorrow has the same value as a dollar today. PBP evaluates the break-
even period of a project. That is, the time it would take for a project to generate the initial cash
outflow (Fabozzi & Markowitz, 2011, p. 54). The Auditizz Electronics will invest in the RTT
project for four years. The project period expires at the end of the fourth year. According to

RRT Project 3
appendix two (in the appendices section), it would take 4.24 years to recover the initial cash
outflow of 4122,775,000.
2) The net Accounting Rate of Return (ARR) of the project
The Accounting Rate of Return (ARR) is also a non-discounted project evaluation method used
by investors to evaluate the viability of a project. ARR is calculated by dividing the expected
average annual profit by the initial investment (Damodaran, 2002, p. 117). The average yearly
profit of the project over the four years is $ 18,164,072.5. On the other hand, the average initial
investment of the project is $71,637,500. The ARR is 25.4% after dividing the two values.
Therefore, The Auditizz Electronics will have a 25.4% of the profit from every dollar invested in
the project.
3) Calculate the NPV and IRR of the project of the project
Both the NPV and the IRR project valuation techniques consider the time value of money. The
viability of a project is determined using the present value of the discounted future cash flows.
NPV is calculated by finding the difference between the discounted future cash flows and the
initial cash outflow. A project is accepted if it has a positive NPV and rejected if it has a negative
NPV. On the other hand, IRR is used to test the profitability of a project by comparing the IRR
and the cost of capital. A project should be accepted if the IRR is higher than the cost of capital;
otherwise, it should be rejected (Bierman & Smidt, 2014, p. 71).
The NPV for the RRT project (as shown in the appendices section) is. $4,733,783.9 Therefore,
the project should be accepted. Likewise, the IRR of the project is 12.5489% while the
company’s cost of capital is 11%. Therefore, the projected should be accepted because the IRR is
higher than the cost of capital.

RRT Project 4
4) The NPV’s sensitivity to changes in price and quantity sold
Sensitivity analysis is based on the “what if” scenario. The technique can be used to test how
sensitive the NPV is to the changes in the product price or quantity sold. A positive NPV portrays
a project as viable. However, NPV is calculated based on future projections, which can be
influenced by market forces. For example, a company be forced to revise the product price by
either reducing or increasing it (Levy, 2015, p. 88). The price of a product is reduced if the sales
are low or the competition is high. Therefore a company can be forced to reduce the price to
increase its sales volume and have a competitive advantage. The same case applies to the quantity
sold. An increase in the price or quantity sold would lead to an increase in the NPV when all the
other factors remain constant. On the other hand, a decrease in the price or quantity sold would
lead to a reduction of the NPV (Houghton, et al., 2010, p. 111). However, the percentage of such
changes should be calculated to determine whether or not the project is still viable after the
reductions in price and quantity sold.
Auditizz Electronics projects that it will sell 105, 000, 156,000, 189,000 and 175,000 pieces of
RRT is the first, second, third and fourth year respectively. The price per unit of RRT will be
$850 in the first year and increase by 3% each year afterwards. Based on the prices and quantities
sold, the company will have a positive NPV of $4,733,783.9
a) What if the price reduces by 10% over the four years
A reduction of the price by 10% of the four years would result in $765, $787.95, $ 811.62, and
$836.01 between year one and year four respectively. A 10% decrease in price would lead to a
negative NPV of $ -18,815,057.92.

RRT Project 5
b) What if the price increase by 10% over the four years
An increase in the price by 10% of the four years would result in $935, $7963.05, $991.98, and
$1021.79 between year one and year four respectively. A 10% increase in price would lead to a
positive NPV of $ 28,282,625.72
c) What if the quantity sold reduces by 10% over the four years
A decrease of the quantity sold by 10% of the four years would result in 94,500, 140,400,
170,100 and 157,500 between year one and year four respectively. A 10% decrease in quantity
sold would lead to a negative NPV of $-5,688,654.49.
d) What if the quantity sold increases by 10% over the four years
An increase in the quantity sold by 10% of the four years would result in 115,500, 171,600,
207,900, and 192,500 between year one and year four, respectively. A 10% increase in quantity
sold would lead to a positive NPV of $ 15,156,222.29.
The sensitivity analysis of the NPV can be summarised, as shown in the table below.
Items % change % change in NPV
Price of product -10 -497
+10 497
Quantity sold -10 -220
+10 220

RRT Project 6
The NPV of the RRT product is highly sensitive to changes in price and quantity sold.
a) A 10% increase in price would lead to a 497% reduction in NPV.
b) A 10% decrease in price would lead to a 497% increase in NPV.
c) A 10% increase in quantity sold would lead to a 200% decrease in NPV.
d) A 10% decrease in quantity sold would lead to a 200% increase in NPV.
5) Forecasting risk and risk management
There are three types of forecasting risks associated with the project. First, the management
might have relied upon a static view while conducting the forecasting. Static view is based on the
traditional forecasting technique where a single metric of estimation is used. The static view does
not support the correlation of multiple risk factors. Second, the forecast might suffer from
overreliance of guesswork over facts. Enterprises tend to base forecasting on guesses across the
industry without considering the risk factors associated with the key variables such as
competition, regulatory pressure and cost and price volatility. Third, failure to conduct adequate
stress testing also increases the volatile performance of a project. Forecasting on a single
parameter of a product such as input cost, demand and price lead to volatility (Pettit, 2011, p. 55).
The implication of forecasting risks can be managed by applying analytical modelling techniques.
Analytical forecasting techniques takes multiple risk factors into account instead of a single
element. The processes provide several probable outcomes. Therefore, the management can
measure future cash flows based on the impact of the possible risks drivers. The method provides
a highly accurate estimation of the cash flows (Miglo, 2016, p. 90).

RRT Project 7
6) Investment decision
The company should invest in a project based on DCF technique analysis. First, the payback
period falls within the project period (4.24 years). Second, a 25.4% profit will be realised from
every dollar invested. Third, the project has a positive NPV. Fourth, the IRR (12.55%) is higher
than the cost of capital (11%).
7) “A positive NPV indicates a project is expected to give a return greater than the market
requires.” Discuss in relation to the efficient market hypothesis (EMH).
The efficient market hypothesis (EMH) states that no single investor or investment can have
higher returns than the market. EMH considered by the past and present information about a
project/ market to determine the price. The market price is considered to be perfect, which
hinders undervaluation or overvaluation of projects (Cover, 2009, p. 93).
There are three forms of EMH. First, Weak EMH relies on the past public information to
determine the price of an investment. Second, Semi-strong EMH relies on the past and present
information available in public to determine the prices. A company’s performance cannot
outperform the market. Third, strong EMH uses both the public and private information to
determine the price of an investment. An investor who takes advantage of positive private
information when investing is likely to outperform the market (Levy, 2015, p. 155).
Based on the analysis, NPV can be higher than what the market requires under two scenarios.
First, the company relies on unreleased information to increase the returns. And second, the
company invests in high-risk projects.

RRT Project 8
8) Impact of a positive NPV investment project on the market value of the Corporation
Theoretically, a project with a positive NPV would lead to an increase of a Corporation’s market
value as well as its stock price. The company value is expected to increase by the same amount as
the NPV. Likewise, the stock price is also expected to increase by the same amount as NPV per
share. In reality, however, the impact of a positive NPV is not straight forward (Tjia, 2009, p.
44).
Practically, the impact of a positive NPV on a company value is influenced by the degree of the
expected profitability. For example, the value of the Corporation would increase if the actual
profitability from the projected is higher than the expected profitability. For instance, a
company’s value might fall even with a positive NPV when the actual profitability lower than the
expected one. Therefore, a positive NPV might have two possible effects on the market value of
the Corporation. First, lead to a fall in stock price and subsequent fall in market value when the
actual profitability is lower than the expected profitability. And second, lead to an increase in
stock price and a subsequent increase in market value when the actual profitability is higher than
the expected profitability (AnalystPrep, 2018).
Conclusion
The study relied on the discounted cash flow (DCF) valuation technique used to determine the
present value of the Auditizz Electronics’ RRT investment project. Both non discounted and
discounted project evaluation techniques have been used to analyse the viability of the projected.
According to the PBP, the initial invested capital will be invested within the project period. On
the other hand, a 25.4% profit will be generated from every dollar that has been invested in the

RRT Project 9
project. The discounted project techniques, such as NPV and IRR, have also shown positive
returns. The Corporation should go ahead and invest in the project.
An advantage of DCF is that is taken into accounts several risks factors such as inflation, increase
in cost and competition that are likely to impact the performance of the project. Moreover, DCF
considers the time value of money by discounting the future cash flow at their present value. The
project has also put in place a reliable risk management technique that considers the impact of
multiple risk factors. The project has a positive, which means that the project will outperform the
market, leading to a higher market value for the company.

RRT Project 10
References List
AnalystPrep, 2018. NPV as a Capital Budgeting Evaluation Method. [Online]
Available at: https://analystprep.com/cfa-level-1-exam/corporate-finance/npv-capital-budgeting-
evaluation-method/
[Accessed 20 May 2019].
Baker, H. K. & Martin, G. S., 2011. Capital Structure and Corporate Financing Decisions:
Theory, Evidence, and Practice. New York: John Wiley & Sons.
Bierman, H. & Smidt, S., 2014. Advanced Capital Budgeting: Refinements in the Economic
Analysis of Investment Projects. New York: Routledge.
Cover, F., 2009. Managerial Judgement and Strategic Investment Decisions. Reprint ed.
Heinemann: Butterworth-Heinemann.
Damodaran, A., 2002. Investment Valuation: Tools and Techniques for Determining the Value of
Any Asset. New York: John Wiley & Sons.
English, P., 2011. Capital Budgeting Valuation: Financial Analysis for Today's Investment
Projects. 1 ed. New York: John Wiley & Sons.
Fabozzi, F. J. & Markowitz, H. M., 2011. The Theory and Practice of Investment Management:
Asset Allocation, Valuation, Portfolio Construction, and Strategies. New York: John Wiley &
Sons.
Houghton, K. A., Jubb, C., Kend, M. & Ng, J., 2010. The Future of Audit: Keeping Capital
Markets Efficient. New York: ANU E Press.

RRT Project 11
Levy, H., 2015. Stochastic Dominance: Investment Decision Making under Uncertainty. New
York: Springer.
Miglo, A., 2016. Capital Structure in the Modern World. London: Springer.
Pettit, J., 2011. Strategic Corporate Finance: Applications in Valuation and Capital Structure.
New York: John Wiley & Sons.
Tjia, J., 2009. Building Financial Models, Chapter 1 - A Financial Projection Model, Part 1.
New York: McGraw Hill Professional.
1. Appendix
Appendix One:
YEAR 0 1 2 3 4
Units sold 105,000 156,000 189,000 175,000
Price Per Unit 850 875.5 901.8 928.9
Variable cost per Unit 515 525.3 525.3 525.3
Cash outflow
Developing RRT 10,125,000
Marketing Study 9,150,000
Equipment 103,500,000
Revenues 89250000 136578000 170440200 162557500
Expenses
Fixed Expenses 11200000 11200000 11200000 11200000
Variable Expenses 54075000 81946800 99281700 91927500
Total Expenses 65275000 93146800 110481700 103127500
EBITDA 23975000 43431200 59958500 59430000
Less: Depreciation 20,750,000 20,750,000 20,750,000 20,750,000
Gross Profit 3,225,000 22,681,200 39,208,500 38,680,000

RRT Project 12
Less: Tax (30%) 967500 6804360 11762550 11604000
Net Profit 2,257,500 15,876,840 27,445,950 27,076,000
Add back: Depreciation 20750000 20750000 20750000 20750000
Add: Residual Value 20500000
Add: Working capital 22312500
Free Cash Flow -122,775,000 23,007,500 36,626,840 48,195,950 63,562,500
Depreciation = (103,500,000-20,500,000)/4
= 20,750,000
Appendix Two: Payback period
Year Non-discounted Cash flow Cumulative Cash Flow Positive
0 -122775000 FALSE
1 23007500 -99767500 FALSE
2 36626840 -63140660 FALSE
3 48195950 -14944710 FALSE
4 63562500 48617790 TRUE
Payback Period= 4 years + (14,944,710/ 63,562,500) = 4.24 years
Appendix Three: ARR
Year Net Profit
1 2257500
2 15876840
3 27445950
4 27076000
Total Profit 72656290
Investment period 4
Average annual profit 18164072.5
Average Initial cash outflow
Initial investment 122775000
Residual value 20500000
Total 143275000
Average initial investment 71637500
ARR 25.35553656

RRT Project 13
Appendix Four: NPV & IRR
YEAR 0 1 2 3 4
Units sold 105,000 156,000 189,000 175,000
Price Per Unit 850 875.5 901.8 928.9
Variable cost per Unit 515 525.3 525.3 525.3
Cash outflow
Developing RRT 10,125,000
Marketing Study 9,150,000
Equipment 103,500,000
Revenues 89250000 136578000 170440200 162557500
Expenses
Fixed Expenses 11200000 11200000 11200000 11200000
Variable Expenses 54075000 81946800 99281700 91927500
Total Expenses 65275000 93146800 110481700 103127500
EBITDA 23975000 43431200 59958500 59430000
Less: Depreciation 20,750,000 20,750,000 20,750,000 20,750,000
Gross Profit 3,225,000 22,681,200 39,208,500 38,680,000
Less: Tax (30%) 967500 6804360 11762550 11604000
Net Profit 2,257,500 15,876,840 27,445,950 27,076,000
Add back: Depreciation 20750000 20750000 20750000 20750000
Add: Residual Value 20500000
Add: Working capital 22312500
Free Cash Flow -122,775,000 23,007,500 36,626,840 48,195,950 63562500
PV factor 100% 90% 81% 73% 66%
PV of cash flow -122775000 20706750 29667740.4 35183043.5 41951250
NPV 4733783.9
IRR:
Project Time
0 1 2 3 4
Cash flows -$122,775,000 $23,007,500 $36,626,840 $48,195,950 $63,562,500
IRR 12.5489%