Detailed Capital Budgeting Analysis for Pinto Ltd Project

This report, addressed to the CEO of Pinto Limited, presents a comprehensive capital budgeting analysis of a proposed project. The analysis includes base case evaluations using metrics such as Net Present Value (NPV), Payback Period, Discounted Payback Period, Profitability Index (PI), and Internal Rate of Return (IRR). The report also incorporates uncertainty analysis, sensitivity analysis (examining the impact of changes in discount rate, sales units, and working capital), and scenario analysis to assess the project's robustness under different conditions. The conclusion, based on the detailed financial analysis and the positive outcomes across various metrics, is a recommendation to accept the proposed project, as it is expected to generate positive cash flows and returns exceeding the costs, provided the assumptions made hold true.

Accounting and Finance

To : CEO, Pinto Limited
From : STUDENT’S NAME
Date : 16TH MAY, 2018
Subject : Recommendation for new proposed project
In order to understand the feasibility of the proposed plan, we have conducted the capital
budgeting technique with of help of projected cash flows. The detailed research on the
proposed project has helped us evaluate the viability project.
Base case analysis:
Using the data from the market research we have calculated few capital budgeting metrics for
the proposed project. These metrics will help us come to a conclusion on the financial
viability of the project:
Particulars Result Comment
Net present
value
$5,605,816 Net present value is the capital budgeting tool which helps the
investor calculates the present value of cash benefits expected
to be earned (Adelaja, 2015). It is the difference between the
present value of cash inflows and cash outflows. If PV of cash
inflows is higher than the project should be accepted else not.
In the given scenario the project is expected to have a positive
net present value. Hence the project seems to create wealth
and should be accepted.
Pay-back
period
2.73 years Pay-back period is another capital budgeting tool which helps
the investor analyse the period within which the amount
invested in a project will be recovered. (Dayananda, Irons,
Harrison, Herbohn, & Rowland, 2008) Generally id pay- back
period is lower than the project period the project is accepted.
In the given proposal the investment period is of 6 years and
the pay-back period is expected to be 2.73 years. Therefore
the proposal has a low pay back period and the project should
be accepted.
Discounted 3.38 years Discounted pay- back period is the capital budgeting tool

pay-back
period
similar to pay back period. (Bierman & Smidt, 2010) The
cash flows used in determining the investment recoverable
period are discounted cash flows. This is generally higher
than the normal pay- back period. The discounted pay back
for the project is 3.38 years. This is lower than the project
period and hence the project should be accepted.
Profitability
Index
1.31 times Profitability index is the tool which assists the investor to
calculate the profitability of the project. (Peterson & Fabozzi,
2012) This tool helps calculate the earning per dollar invested.
The PI for the said proposal is 1.31 times. This indicates that
the project is expected to earn $1.31 for every dollar used in
the project. Since the earnings are more than investment the
project should be accepted.
Internal Rate
of return
21.14% Internal rate of return helps calculate the actual return on the
project. (Piper, 2015)Based on expected cash flows the
internal rate of return is calculated. If the IRR is equal or
more than the discount rate used, then the project should be
accepted. In the given case the IRR is 21.14% which is more
than the discount rate and therefore the project should be
accepted.
Uncertainty analysis:
The new project which is up for discussion is based on a whole lot of data extracted with the
help of market research. The market research done for these projects are very detailed and
based on a lot of assumptions. (Rivenbark, Vogt, & Marlowe, 2009) It is not easy to
determine the expected cash flows and required rate of return for a new proposal. These
results of market research are based on the economy existing before the execution of the
proposal. The market is uncertain and even a very small information may result in changes in
the outcome of the proposal. Therefore, there is always a risk of uncertainty in capital
budgeting planning.
Sensitivity Analysis:

Sensitivity analysis is the part of capital budgeting analysis which helps to understand the
sensitivity of the project outcome based on changes in its input (Seitz & Ellison, 2009). We
have conducted the sensitivity analysis of the said proposal with respect to change in the
discount rate, change in sale units and in change in working capital requirements. The
following graph shows the sensitivity of the project outcome with respect to these inputs:
-2% -1% 0% 1% 2%
$4,600,000
$4,800,000
$5,000,000
$5,200,000
$5,400,000
$5,600,000
$5,800,000
$6,000,000
$6,200,000
WACC
Units sold yr1
NWC% yr1 rev
From the above graph we can see that the slope of the line representing the sensitivity with
respect to units sold is the steepest, this indicates that the project outcome is most sensitive to
change in units sold. Therefore while conducting the capital budgeting analysis these inputs
should be chosen very carefully.
Scenario analysis
Scenario analysis is the tool which helps us understand the outcome of the projects if there
are changes in the inputs. We have analysed three scenarios for the company:
Scenari
o
Rate of
return
Units
Sold
NPV Remarks
Positive 9% 230000 $9446795 The scenario with maximum sales with
least cost.
Neutral 10% 200000 $5605816 The scenario with the most likely to
happen inputs.
Negative 11% 170000 $1977589 The scenario with maximum costs and
minimum sales.

Conclusion and Recommendation
The above capital budgeting analysis and implementation of various detailed analysis has
helped us make an opinion on the acceptability of the proposal (Shapiro, 2007). The said
project is likely to create positive values for the firm given that all the assumptions made
come true. In case there are variances in the assumptions made the results may differ. But the
case which is most likely to happen indicates that the project will generate positive cash
flows for the company. The returns earned are more than cost and 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.