Assume that your group is working in Finance Department of a construction company. Your company is considering the potential project as follow:

Launching a new construction project. There are two options available for the company management's consideration. Option 1 is building an apartment in the city centre and option 2 is building a new residential community in a suburban area. It is estimated that within five years, the company can gradually build up and sell all the properties in two options. The company is currently facing soft capital rationing. The table below shows the estimated cash flow available to the company's Management:

Option 1 Option 2 Initial Investment 12,235,000 16,215,000 Annual cash inflow Year 1 4,390,000 5,315,000 Year 2 4,320,000 6,345,000 Year 3 5, 360,000 6,356,000 Year 4 5,375,000 5,402,000 Year 5 4,480,000 5,540,000

You are required to write a short report to the company's Management:

1) To select a relevant method among five investment criteria of Net Present Value (NPV), Equivalent Annual Cost (EAC), profitability Index (PI), Internal Rate of Return (IRR), Simple Payback Period, and Discounted Payback Period for this project, given the market required rate of return for all project is 12.5% and the company's benchmark of payback is maximum 3 years. Your recommendation must include your justification on why you choose the specific method based on its pros and cons compared to other methods and the financial circumstance of the company. (2 marks) 2) To perform the selected method and present the outcome of your project evaluation and recommend the option 1 or 2 should the company choose for this project. Your justification must include calculation steps and numerical outcomes. (5 marks)

 

3.2. Risk Analysis and Project Evaluation: NPV Sensitivity Analysis 

 

HI5002 Finance for Business Group Assignment T2 2021

Case Study: Assume that your group is working in Finance Department of a production company. Your company is considering to buy a new assembly line for launching a new product. With the new assembly line, the company expects to sell 6,500 products/ year for an average price of $350 per unit for 5 years. The new assembly line has the initial cost of $1,550,000, a residual value of $250,000 at the end of the project. The company will need to add $450 000 in working capital which is expected to be fully retrieved at the end of the project. Other information is available below:

Depreciation method: straight line Variable cost per unit: $190 Cash fixed costs per year: $200,000 Corporate marginal tax: 30%

Upon the forecast of unexpected economic conditions that may be caused by the current breakout of corona virus, the company management requires your Team to prepare a risk analysis for the case where:

Unit sales decrease by 15% Price per unit decreases by 15% Variable cost per unit increases 15% Cash fixed cost per year increases by 15%

Required: Do an analysis with cash flows of the project to determine the sensitivity of the project NPV with the above estimated changes in the value drivers and provide your results in relevant tables.

Conclusion Summarize / Reflection the outcomes of your group's works)