Financial Analysis: Evaluating the Feasibility of Ferry Construction

This memorandum presents a comprehensive financial evaluation of a proposed ferry construction project for Water Pty Ltd. The analysis assesses the project's feasibility and profitability using various capital budgeting and investment appraisal techniques, including Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index, and Discounted Payback Period. The report considers an initial investment of $10 million, projected revenues, variable costs, and a 7% weighted average cost of capital. The analysis reveals a positive NPV of $12.92 million and an IRR of 33.44%, indicating the project's financial viability. Sensitivity analysis is also included to assess the impact of changes in revenue projections. The report concludes that the project is feasible and recommends its acceptance, also considering non-financial factors like environmental impact and social welfare. The analysis includes detailed calculations of free cash flows, depreciation, and the application of investment appraisal techniques, supported by relevant academic references.

Running head: FINANCE
Finance
Name of the Student:
Name of the University:
Author’s Note:

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MEMORANDUM
To : The CEO, Water Pty Ltd.
From : [Name, Designation]
Date : January 28, 2020
Subject : Project evaluation
This memorandum is prepared to analyze and explain the potentialities and feasibilities of
the proposed project of construction of ferry and its maintenance. Based on the revenue
assumptions and respective expenses, various capital budgeting and investment appraisal
techniques have been applies to evaluate the feasibility of the proposed project.
Gold Coast City Council has been assessed a need for construction of a ferry for
providing a shorter and convenient transportation facilities to the citizens of the city. The ferry
service will be provided at a cost to the citizens and it can become a source of revenue for the
Gold Coast City Council. Hence, before making investment in the project, its profitability,
feasibility and significance must be evaluated and assessed properly. In the following part of this
memorandum, the financial aspects of the project, such as investment needs, and expected
revenues arising from the project, have been analyzed and evaluated using various investment
appraisal techniques, such as net present value method, internal rate of return, profitability index
and accounting rate of return.
It has been assumed that the project will require and initial investment of $10 million and
it will generate annual revenue of $15 million with a 5% growth in revenue. On the other hand,
the will be a variable cost of $8 million with a growth of 4% in the annual variable costs.

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Considering a 7% weighted average cost of capital as the discounting rate following investment
appraisal techniques can be applied.
It can be observed that the project can generate a significant amount of positive cash
flows over the 7 years life of the project. If the free cash flows generated by the project are
discounted by the discounting factor at 7%, then the discounted cash flows are well enough to
recover the initial investment within 4 years. Using the free cash flows as computed above
following results can be arrived at for evaluation of the project.
Over the 7 years life of the project, the sum of discounted cash flows is considered as the
net present value of the project. It can be observed that the project is having a net present value
of $12.92 million. The acceptance criteria for the net present value is to select an invest
opportunity which is having a positive net present value. As the proposed project of the

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construction and maintenance of the ferry is having a positive net present value, the proposal can
be accepted. Internal rate of return is another important investment appraisal technique which
can be used for evaluating the future profitability and feasibility of any investment opportunity.
It can be observed that the internal rate of return of the proposed project is 33.44% while the
weighted average cost of capital is 7%. The acceptance criteria for the internal rate of return is to
accept an investment proposal having an internal rate of return more than the weighted average
cost of capital. As the proposed ferry project is having an internal rate of return of 33.44% which
is much greater than the weighted average cost of capital, the proposed project is feasible and
can be accepted.
It has been assumed that the life of the project would be 7 years. Hence, the initial
investment must be recovered back within the life of the project. To test this significance, the
discounted payback period method can be applied. It can be observed that the project is having a
discounted payback period of 3.34 years. It implies the discounted cash flows arising from the
project will become equal to the initial investment within the 387 years. As the initial investment
is recovered back much before the end of the estimated life of the project, the project can be
considered as feasible and significant for making investment. One more measure of profitability
index and accounting rate of return shows a good profitability of the project. Hence, based on the
above results of the investment appraisal techniques, the project can be considered as a feasible
investment opportunity and can be selected for the investment.
The above analysis is based on various assumptions, such as the expected revenue,
variable costs, fixed costs and discounting rates. If any of such parameters deviate from its
expected figure, then the result could be favorable or unfavorable. Hence, there is a sensitivity or
risk to the profitability and feasibility of the project arising from the base assumptions. It can e

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observed that, the expected revenue is having a greater impact on the whole valuation techniques
as applied above. Hence, a sensitivity analysis has been applied as follows to check the change in
net present value with increase or decrease in the expected revenue.
It can be observed that, with the decrease in expected revenue from $15 million to $13
million, the net present value of the project has been decreased to $7.1 million from $12.92
million. Hence, although there is a chance of lower profitability, still it will cause an
accumulation of capital not an erosion of capital. On the other hand, if the expected revenue is
higher, then the net present value will also be increasing. Hence, from this analysis also, the
feasibility of the project can be observed.
There are various other non-financial factors which must be considered for evaluating
such an investment option. It can be observed that, the construction of the ferry will help in an
environment friendly transport and communication system. It will increase the social welfare as a
whole.
From the above analysis and discussion it can be concluded that, the project is feasible in
terms of profitability as well as sustainability. It will help in increasing the social welfare. Hence,
the proposed project can be accepted for investment.
[Name]
[Designation]

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Bibliography
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and Eastern European firms. Emerging Markets Review, 23, 148-172.
Batra, R., & Verma, S. (2017). Capital budgeting practices in Indian companies. IIMB
Management Review, 29(1), 29-44.
Baum, A. E., & Crosby, N. (2014). Property investment appraisal. John Wiley & Sons.
Daunfeldt, S. O., & Hartwig, F. (2014). What determines the use of capital budgeting methods?:
Evidence from Swedish listed companies. Journal of Finance and Economics, 2(4), 101-
112.
de Andrés, P., de Fuente, G., & San Martín, P. (2015). Capital budgeting practices in
Spain. BRQ Business Research Quarterly, 18(1), 37-56.
Harris, E. (2017). Strategic project risk appraisal and management. Routledge.
Rossi, M. (2014). Capital budgeting in Europe: confronting theory with practice. International
Journal of Managerial and Financial Accounting, 6(4), 341-356.
Rossi, M. (2015). The use of capital budgeting techniques: an outlook from Italy. International
Journal of Management Practice, 8(1), 43-56.

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Steps for calculating free cash flows and application of investment appraisal techniques
To compute the annual revenue the estimated revenue for the first year has been inflated with the
expected growth rate.
In the same way the annual variable costs have also been inflated with the expected growth rate
in variable costs.
Annual fixed costs remains same over the projected period and the annual depreciation has been
calculated using the straight line method.
Then subtracting the total expenses from the annual revenue the profit before has been
calculated. Then the interest expenses has been deducted to find the profit before tax.
After providing for the tax expenses, the depreciation expenses and the interest expense has been
added back again to find the cash flow generated from the operations.
Then considering the initial investment in the initial year, the projected free cash flows has been
computed. Taking the weighted average cost of capital as the discounting rate, the discounting
factors have been computed and the sum of all discounted cash flows has been considered as the
net present value of the project.
With the computation of fraction year in which the cumulative cash flows becomes zero, the
discounted payback period has been computed.
Then to check the variability in the net present value with the change in expected revenue, a
sensitivity analysis has been applied.