Assignment - Part 2
Task 1.
Year Revenue COGS ($) Operating Depreciatio Interest Taxes ($)
($) Costs ($) n ($) Expenses
($)
1 400,000 200,000 50,000 120,000 9,900 42,030
2 650,000 325,000 50,000 120,000 9,900 79,530
3 950,000 475,000 50,000 120,000 9,900 124,530
4 850,000 425,000 50,000 120,000 9,900 109,530
5 450,000 225,000 50,000 120,000 9,900 49,530
Year Net Income Depreciatio Change in Interest Debt Free Cash
($) n ($) Working Expenses Repayment Flow ($)
Capital ($) ($) ($)
0 - - -40,000 - - -640,000
1 98,070 120,000 -25,000 9,900 - 202,970
2 185,570 120,000 -30,000 9,900 - 285,470
3 290,570 120,000 10,000 9,900 - 430,470
4 255,570 120,000 40,000 9,900 - 425,470
5 115,570 120,000 45,000 9,900 -180,000 110,470
Task 2
WACC = ( E / V * re ) + ( D / V * rd * ( 1 - T ) )
re= Rf+ βe* ( Rm − Rf )
βe= βAsset Avg* 1 + ( ED* ( 1 − T ) )
D / E = ( D / V ) / ( E / V )
βAsset Avg = 5βStrideMax + βEcoRun Gear+ βProFlex Footwear + βTerraTread + βSprintX
Sports
= 1.3 + 0.9 + 1.2 + 1.0 + 1.6 / 5= 6 / 5 = 1.2
D / E = ( D / V ) / ( E / V = 0.30 / 0.70 = 0.4286
βe= βAsset Avg* 1 + ( ED* ( 1 − T ) ) = 1.2 * ( 1 + ( 0.4286 * 0.7 ) ) = 1.56
re= Rf+ βe* ( Rm − Rf ) = 3.5% + 1.56 * 6% = 12.86%
RD ( Loan interest rate ) = 5.5%
WACC = ( E / V * re ) + ( D / V * rd * ( 1 - T ) ) = ( 0.70 * 12.86% ) + ( 0.30 * 5.5% * 0.7 )
= 10.16%
Task 3
Discount factors with WACC -> 10.157% :
Year 1: DF1= ( 1.10157 ) ^1 = 1.10157
Year 2: DF2= ( 1.10157 ) ^2 =1.21343
Year 3: DF3= ( 1.10157 ) ^3 = 1.33777
Year 4: DF4= ( 1.10157 ) ^4 = 1.47575
Year 5: DF5 = ( 1.10157 ) ^5 = 1.63052
Present Value of each year ( PV of t = Cash Flow of t / Discount Factor of t)
Year 0: PV of 0 = $640,000/ 1 = − $640,000
Year 1: PV of 1 = $202,970/ 1.10157 = $184,184.54
Year 2: PV of 2= $285,470/ 1.21343 = $235,362.36
Year 3: PV of 3 = $430,470/ 1.33777 = $321,913.77
Year 4: PV of 4 = $425,470 / 1.47575 = $288,370.87
Year 5: PV of 5 = $110,470 / 1.63052 = $67,746.63
Total PV= $184,184.54 + $235,362.36 + $321,913.77 + $288,370.87 + $67,746.63 =
$1,097,578.17
Net Present Value (NPV)
NPV = ( ( cash flow / ( 1 + i ) ^t ) ) - initial investment = Total PV − Initial Investment
= $1,097,578.17 − $640,000
= $457,578.17
The NPV is positive so the project is financially viable.
Task 4: Internal Rate of Return - IRR
The step-by-step procedure to calculate IRR goes as follows:
Cash Flows:
Initial Investment Year 0: $640,000
Year 1 Cash Flow: $202,970
Year 2 Cash Flow: $285,470
Year 3 Cash Flow: $430,470
Year 4 Cash Flow: $425,470
Year 5 Cash Flow: $110,470
The IRR is that discount rate at which the NPV of these cash flows is forced to equal zero. It
can be found by solving the equation:
Where: Ct is cash flow in year t,
n is the total number of periods (here 5 years),
IRR is the internal rate of return.
IRR Calculation: Using financial functions—as was performed programmatically—we
iteratively solve for the discount rate which equates the present value of the cash inflows to
the initial investment. The calculated IRR is approximately 34.56%.
What this means is that the rate of return the project is expected to throw out is 34.56%.
Since it is more than the WACC of 10.16%, it is sure to create value.
Task 5
Changes for Scenario Analysis:
Gloomy Scenario: -Discount rate: since the WACC is to be increased by 2%, the new
WACC would be 10.16% + 2% = 12.16%. -Revenues: revenues are gonna decrease by
10%.
Rosy Scenario:
Discount rate: Take WACC and reduce it by 2%, therefore the new WACC = 10.16% - 2% =
8.16%
Revenues: Take revenues and increase them by 10%.
First, for both the base and rosy scenarios, adjust revenues then recalculate an updated
NPV for each.
Results of scenario analysis:
Gloomy Scenario:
Discount Rate: 12.16%
Revenues: 10% lower
NPV: $874,163.62
This scenario would mean that the NPV is highly negative; therefore, under worsened
market conditions, the project will not be financially viable.
Rosy Scenario:
Discount Rate: 8.16%
Revenues: 10% higher
NPV: $564,535.67
Even in this optimistic case, the NPV remains negative, though better than under the gloomy
situation. However, from this analysis too, the project could still not be commercially viable.
Conclusion: From both the pessimistic and optimistic scenarios, the financial viability of the
project decreases, and the NPV remains negative in both analyses.
Shall we go ahead with Task 6 and the final recommendations?
Task 6
Financial Viability
Base Case: The NPV is $457,578.17, and the IRR is 34.56%, indicating that the project is
viable financially under the original assumptions.
Gloomy Scenario: The project, under a higher discount rate of 12.16% and revenues lower
by 10%, results in an NPV turning highly negative at -$874,163.62, showing a high-risk
factor under adverse market conditions.
Rosy Scenario: Even under a more favorable set of circumstances, assuming a lower
discount rate and revenues increased by 10%, the NPV is −$564,535.67, indicating only that
the project may shallowly create value under the most favorable of circumstances.
Risk and Sensitivity This project shows high sensitivity regarding changes in revenues and
the cost of capital. In the "gloomy" case, a minor decline in the market conditions has
disproportionately changed its financials to the very sensitive condition, which could indicate
that the project itself may involve considerable risk if market conditions are unstable or
unpredictable.
Recommendations From the results of the analyses, mixed financial perspectives could be
seen in the project. While the base case provides a positive value, the pessimistic and
optimistic cases have negative NPVs.
Recommendations here are:
Go/No Go Decision:
Revise the Forecasts: Re-consider the revenue forecasts and the market volatility before
proceeding. Spend additional time conducting market research to confirm that the base case
revenues have a high likelihood of being met or exceeded.
Risk Mitigation: The company can dwell on its strategy to mitigate the potential risks that will
improve financial outcomes as follows:
Cost Reduction: The Company must focus on reduction of operating cost and COGS with a
view to increase free cash flows. Operational efficiencies or better supplier terms can lead to
improvement in the bottom line.
Diversifying Revenue Streams: It has to look at ways to diversify streams of revenue,
probably by offering complementary products or services that enhance sales in varying
market conditions.
Alternative Strategy: If the company is not so confident about the project's financial viability,
it aims to enhance returns. It has to do with:
Strategic Partnership or Outsourcing: Form partnerships or outsource segments of
production processes as a means of cutting down pre-production costs and operation
expenses. That would reduce the initial investment, thereby potentially increasing the NPV.
Delay or Scale Down: To expose less financially, the product can be launched on a smaller
scale. Or it can be delayed until conditions are more favorable.
Final Decision
The project should be accepted if it is believed that major control of costs can be exercised
and revenue forecasts achieved. If the risks seem too great, pushing the project into the
future or working on ways to enhance profitability before undertaking a project could be
advisable.
