BAF-5-FOF Coursework: Analysis of Project Evaluation Techniques

This report provides a comprehensive analysis of project evaluation techniques, focusing on the assessment of single and mutually exclusive projects. It examines the characteristics of project evaluation, emphasizing the involvement of significant funds and irreversible decisions. The report explores various evaluation methods, including Cash Payback Period, Net Present Value (NPV), Internal Rate of Return (IRR), and Profitability Index, along with the Weighted Average Cost of Capital (WACC) calculation. It utilizes the Gordon Growth Model to determine the cost of equity and compares different projects using NPV, IRR, and Payback methods. The analysis highlights the benefits and shortcomings of each technique, recommending the selection of Option 1 based on a higher NPV with the WACC and considering qualitative factors. The report concludes by emphasizing the importance of careful evaluation, the impact of different methods on results, and the need for input from departmental heads in investment decisions. References to relevant academic sources are also included.

BUSINESS FINANCE

CHARATERISTICS OF PROJECT EVALUATION
 Single project assessment or assessment of
mutually exclusive projects.
 Huge funds involved (Berman, Knight and
Case, 2013) .
 Irreversible decisions (Bierman Jr, and Smidt,
2012) .
 Resources involved: Technology, Manpower,
Time ansd Efforts.

PROJECT CHOICES
 Choice 1: Introduction of a new product for
the low-end market.
 Choice 2: Expansion of market for the
existing product.
 Above projects are mutually exclusive
projects.
 Selection of one option would lead to the
rejection of the other option.

METHODS OF EVALUATION
 Cash Payback Period
 Net Present Value
 Internal Rate of Return
 Profitability Index
 Accounting Rate of Return
 Discounted Cash Pay Back, and others.

WEIGHTED AVERAGE COST OF CAPITAL
 Total average cost of different sources of
capital in an entity (Brigham and Houston,
2012) .
 Based on either market value weights or book
value weights.
 First Step: Calculate individual source of
finances.
 Second Step: Apply weights to the respective
cost of capital.

COST OF DEBT
 After tax cost of debt forms the part of WACC.
 Cost of debt of entity Chowkidar plc:
Coupon per bond (C)
= 4%
Coupon per bond (C)
= 4.00
Face Value of Bond
(FV) = 100
t = 7
Market Price (PV) = 91.5
Kd =
(4 +
((100-91.50)/7))/((100+91.50)/2)
Kd =
0.05445729
2
Kd = 5.45%
Kd (after tax) = 4.41%

COST OF EQUITY
 Various methods used: CAPM, Gordon’s Growth
Model, Dividend Discount Mode, and others.
 Gordon Growth Model used for computing cost
of equity of Chowkidar Plc.
Ke (Cost of equity )
= (D *(1 + g))/ P + g
Where,
D = Dividend last paid
G = Growth Rate
P = Current market price
G = 4.55%
Ke (Cost of
equity ) =
((0.14*(1 + 4.55%)) /100) +
4.55%
Ke (Cost of
equity ) = 4.6964%
Ke = 4.70%

WEIGHTED AVERAGE COST OF CAPITAL
 The respective weights are multiplied with the
individual cost of capital of different finance
source. Computation of WACC
Ratio of bonds = 0.59
Ratio of mezzanine finance = 0.4
Ratio of equity = 0.1
Cost of Equity = 4.70%
Cost of Debt = 4.41%
Cost of Mezzanine Finance = 8%
WACC = 3.93%

COMPARATIVE EVALUATION OF THE
PROJECTS
 Varied results in varied scenarios.
Description Option 1 Option 2
NPV WACC 5903683.28 39651249.67
NPV
(Mezanninne
Rate)
-4072975.34 31414781.28
IRR 6.22% 33%
PAYBACK (YRS) 5.73 2

SELECTION BASED ON VARIOUS
TECHNIQUES
Description Option 1 Option 2 Selection
NPV WACC 5903683.2
8
39651249.
67
Option 1
NPV
(Mezanninn
e Rate)
-
4072975.3
4
31414781.
28
Option 2
IRR 6.22% 33% Option 2
PAYBACK
(YRS)
5.73 2 Option 2

COMPARATIVE EVALUATION OF THE PROJECTS
 Method used for evaluation: NPV, IRR, PAYBACK.
 Method considered for selection: NPV
 Benefits of NPV:
Considers time value of money (Gὂtze, Northcott and
Schuster, 2015) .
Gives outcome in absolute form.
 Disadvantages of NPV:
Complex to perform (Moran, 2015).
Difficult to determine cost of capital.
Qualitative factors are ignored.

SHORT COMINGS OF VARIED EVALUAITON
TECHNIQUES
 Cash Payback Period: The technique does not
considers the time value of money.
 The method does not considers the cash flow
that arise after the recovery of the initial
costs.
 Does not gives efficient result in case of two
projects with uneven cash flows.