Financial Accounting: Investment Appraisal and Funding for AYR Co.

This report provides a comprehensive analysis of two investment projects, Project Aspire and Project Wolf, for AYR Co., utilizing capital budgeting techniques such as Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period to justify project selection. The report recommends selecting a project and suggests additional factors for consideration beyond capital budgeting results. It also explores appropriate funding sources, including debt and equity, along with their respective costs and impact on the company's weighted average cost of capital. The analysis includes detailed calculations of NPV, IRR, and payback period for both projects, ultimately recommending Project Aspire based on its higher NPV and IRR. The report further discusses the strengths and weaknesses of each capital budgeting technique, emphasizing the superiority of NPV for decision-making. Additional factors such as consumer demand, uncertainty, and economic activity are highlighted for consideration before making a final investment decision. Finally, the report provides a detailed comparison of debt and equity financing, including their costs and implications for AYR Co.

Financial
Accounting
Assignment

Prepared By
Student Name:
Date: 25th November 2018
Executive Summary
This report is intended to provide fruitful information to the
Board of Directors of the AYR Co. in relation to the two
investment opportunities currently available with it, naming
Project Aspire and Project Wolf for which the various Capital
budgeting techniques have been resorted to so that to justify the
decision of selection of a project with the concrete evidence.
Further it also recommends the selection of a project and
suggests the other factors to be kept in mind while making
selection of any investment projector opportunities. It also tries
to make the appropriate choice of sources of funds along with the
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A Brief
Analysi
s of the
evaluati
on of
Investm
ent
options
along
with the
Sources
of
Funds

respective cost of capital and its overall impact on the weighted average cost of capital of the
AYR Co.
Table of Content
s
Executive Summary................................................................................................... 2
Introduction................................................................................................................ 4
Answer to Question No.1............................................................................................ 5
Question No. 2............................................................................................................ 9
Question no.3........................................................................................................... 12
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Conclusion................................................................................................................ 18
References............................................................................................................... 20
Appendix -1.............................................................................................................. 22
Introduction
AYR Co. is currently in the process of considering the proposed investment to be made in one of
its two projects naming Aspire and wolf respectively for which the board is seeking the
appropriate information along with the strong supportive evidence to justify the selection of any
one of these two projects based on the three Capital budgeting Techniques naming Net Present
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value, Internal rate of Return and Payback period respectively due to the Budget constraint .
Both projects have its own unique feature like Project Aspire is seen to expand the current
product range and place an appeal to both the current and potential customers, whereas project
wolf shall provide a new direction by appealing to a new group of customers (Charles H, et al.,
2015). Board is also expecting to have a detailed analysis on the recommended selection of any
one of these projects along with the other factors to be kept in mind while making such selection
in addition to the result obtained from the use of capital budgeting techniques. Finally, Board is
seeking advice on the sources of fundi’s. Debt or equity to be chosen for the funding of the
selected project along with the overall impact of such selection on the weighted average cost of
AYR co (Cundill, et al., 2017).
Answer to Question No.1
[See Appendix 1, Peg No.]
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Before going into the detailed calculation, it is better to have a brief idea on the three of the
Capital Budgeting Techniques, naming Net Present Value, Internal rate of Return and Payback
Period, which have been discussed below:
Net Present Value
It is the method of capital budgeting in which at first the future cash inflows to be generated in
the project are estimated, thereafter this future values of cash inflows are discounted at a rate to
arrive at the present value of future Cash inflows from which the present value of cash outflow,
that is the value of investment proposed to be made in present is subtracted to get the Net present
Value of the project (Kaufmann, 2017). If the value derived is positive, then it is recommended
to select the project otherwise not.
Internal rate of Return
It is the rate of return at which the net present value of the project is zero or in other words it is
the rate at which present value of cash inflow is equal to the present value of cash inflows. The
reason behind calling it the internal rate of return is because it doesn’t consider the external
factors like inflation etc. while determining the rate of return (Bennouna, et al., 2010).
Payback period
Under this method without taking into the time value of money in to the consideration, it tries to
calculate the period which is required to recover the initial capital investment proposed to be
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made in a specific project. It does not consider the cash inflows generated after the payback
period.
i. Computation of NPV of the Project Aspire
=Present value of cash inflow- Present value of cash outflow
=$818000/ (1.1) ^1+$698000/ (1.1) ^2+$677997/ (1.1) ^3+$667309/ (1.1) ^4+$653507/ (1.1)
^5+$140000/ (1.1) ^5+$375000/ (1.1) ^5-$140000-$2250000
=$3011487-$2390000
=$621487
ii. Computation of NPV of the Project Wolf
= Present value of cash inflow- Present value of cash outflow
=$83300/(1.1)^1+$648700/(1.1)^2+$647511/(1.1)^3+$646524/(1.1)^4+$645461/(1.1)^5-
$2250000-$75000/(1.1)^1-75000/(1.1)^2-75000/(1.1)^3-75000/(1.1)^4-75000/(1.1)^5
=$2622238-$2534309
=$87929
iii. Computation of internal rate of return of Project Aspire
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Internal rate of return of the project is that rate at which present value of cash inflow
is equal to present value of cash outflow
Froom the above,
10%=$621487, Rate 1 = 10%, NPV1
X% =$2390000
Taking discount rate 20%, Rate 2
NPV 2=$-39616
IRR= Rate 1+NPV 1(Rate 2 -Rate 1)/NPV1-NPV2
=10%+$621487(20%-10%)/$621487-(-$39616)
=10%+$62148.7/$661103
=10%+9.40%
=19.40%
iv. Computation of internal rate of return of Project Wolf
From the above,
Rate 1=10%=$87929(NPV1)
Rate2 (taken 20%)
NPV = $-383742
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IRR= Rate 1+NPV 1(Rate 2 -Rate 1)/NPV1-NPV2
=10%+$87929(20%-10%)/$87929-(-$383742)
=10%+$8792.9/$471671
=10%+1.86%
=11.86%
v. Payback period for the project Aspire
Total initial investment = $2390000
Year Cash inflows Cumulative cash
inflows
1 818000 818000
2 698000 1516000
3 677997 2193997
4 667309
2861306
5 1168507 4029813
Payback period =3 years+2390000-2193997/667309*12
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= 3.29 Years
vi. Payback period for the project Wolf
Total initial investment= $22500000
Year Cash inflows Cumulative cash inflows
1 818000 818000
2 698000 1516000
3 677997 2193997
4 667309
2861306
5 1168507 4029813
Pay Back Period= 3 yerars+2250000-2193997/667309
=3.08 Years
Question No. 2
Analysis and evaluation of investment project
i. A recommendation on which project to undertake
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On the basis of the above detailed calculation as we can see that the NPV of Project
Aspire is greater than the project Wolf, similarly the Internal Rate of Return of
Project Aspire and Project wolf both the projects are greater than the cost of capital or
the weighted average cost of capital of the company, but IRR in case of Project
Aspire is much higher than the IRR of Project Wolf, though using payback period we
can see that the payback period of Project Aspire is higher than the project wolf, but
still we would recommend the selection of the Project Aspire in the given case (Borit
& Olsen, 2012).
ii. Justification for our recommendation including an evaluation of the investment
appraisal techniques used in 1 above
In this case we need to compare amongst the three capital budgeting techniques used
above that which one is to be based while making our recommendation in i above.
Through the Net present value technique, it becomes possible to discount each cash
flow separately, it is preferable in those cases when the project’s discount rate is also
not known. Though in most of the cases both NPV and IRR are much widely used
techniques, but at times they may provide different results in the scenario when there
are variations found in the estimated cash inflows, cash outflows and in the duration
of the project. At the same time the IRR technique doesn’t consider the impact of
external factors on the discount rate being chosen (Carolus, et al., 2018). Truly
speaking IRR doesn’t provide the absolute value, rather it is expressed in terms of
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certain percentage at which the company shall neither make profit nor loss, hence it
makes the decision-making process rather complicated. At the same time NPV
presents the surplus or deficit (if negative) generated from the project.
The payback period method is associated with the greatest weakness of not
considering the Time value of money factor, hence it shall not be recommended to
reach to a decision based on the result obtained using this technique. It even does not
take into consideration the cash flows generated beyond the payback back period
(Coate & Mitschow, 2017).
Hence in the given case from the above analysis it is quite clear that the use of Net
present value techniques has much more preference over the other two techniques,
hence our recommendation has been based on result obtained through NPV technique
(Hansen, et al., 2003).
iii. A summary of other factors that should be considered and information that may be
needed prior to make a final decision
The following are the additional factors to be kept in mind while making final
decision
a. Consumer demand
b. Element of uncertainty
c. Innovations and inventions
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