Question $1(20$ points$)$

As the Director of Corporate Planning, you always apply the concept of Corporate Value

Added in your review of new proposals for the company. You have been asked to

evaluate $3$ strategic proposals for your firm. The first proposal is to increase your revenue

growth, g$,$ from $5\mathrm{.}5\%$ to $6\%$ while holding everything else at current levels. Proposal $2$ is

a cost control program that increases operating profitability, OP$,$ from the current level of

$8\mathrm{.}0\%$ to $9\mathrm{.}50\%$ holding all else equal. Proposal $3$ is an initiative to improve asset

utilization and thus reduce capital intensity, CR$,$ from $0\mathrm{.}90$ to $0\mathrm{.}85$ while holding all else

the same. Your task is to use the information given below to evaluate all three proposals

and determine the value added for the company.

Based on your analysis, which of the proposals appears to have the most significant

impact on value relative to your current situation? You must complete the table as part of

your recommendation and explanation. Be clear regarding the impact of each value driver

in terms of value creation or destruction. Note: You must make a recommendation

relative to the current situation your firm faces. A choice of $$no change$$ is a possibility.

Original

Position

Proposal $1$ Proposal $2$ Proposal $3$

Sales $($Current$)$ $$1,000$

Growth: g $5\mathrm{.}50\%$

Profitability:

$($NOPAT$/$sales

$)$

$8\mathrm{.}00\%$

Capital

Requirement:

CR$=($Capital $/$

Sales$)$

$\mathrm{.}90$

WACC $10\%$

MVA

Expected

Return on

Invested

Capital

$($EROIC$)$

Question $2$: $(10$ points$)$

Project Analysis

Results

Project $1$ Project $2$ Project $3$

Initial Investment $$260,000$ $$265,000$ $$304,000$

Required Rate of

Return

$10\%10\%10\%$

NPV $$46,754$ $$44,116$ $$49,901$

IRR $17\mathrm{.}09\%16\mathrm{.}72\%16\mathrm{.}69\%$

MIRR $14\mathrm{.}27\%14\mathrm{.}03\%13\mathrm{.}99\%$

Payback $2\mathrm{.}93$ years $2\mathrm{.}93$ years $2\mathrm{.}91$ years

Additional information:

$1.$ Our firm typically likes projects with a payback of $3$ years or less.

$2.$ Projects $1$ and $3$ have non$-$normal cash flows.

In a prior report regarding the proposed expansion of our firm$$s existing product lines,

our management team clearly stated the proposed expansion could not be completed with

the existing fixed assets and, as a result, additional fixed assets would be required to

accomplish this expansion. We are considering three alternative projects that are mutually

exclusive. The results and notes from the basic analysis for each project are provided in

the table above for your review and recommendation to management. Explain which

project you will recommend to management and provide specific data items from the

table to support your position.

Question $3$: $(20$ points$)$

In addition to the recommendation you provided in Question $2,$ the CFO would like your

assessment of the risk and a recommendation regarding the projects. The data provided in

the table below is an expanded view of the data for Project $1.$ Additionally, using the data

in Appendices $1$ and $2,$ complete the necessary calculations for a complete risk

assessment for Project $1.$ While only a limited amount of information is available for

projects $2$ and $3,$ they are highly correlated with project $1.$ As a result of this high

degree of correlation, the CFO believes project $1$ can be used as a proxy to describe

the risks within projects $2$ and $3.$

Note: As a matter of practice, management prefers projects with a risk$/$return profile in

the range of $\mathrm{.}50$ to $1\mathrm{.}00.$

Project Analysis

Results

Project $1$

Initial Investment $$260,000$

Required Rate of

Return

$10\%$

NPV$-$Base case $$46,754$

E$($NPV$)$

$\backslash$sigma $($NPV$)*$

IRR $17\mathrm{.}09\%$

MIRR $14\mathrm{.}27\%$

Payback $2\mathrm{.}93$ years

CV

$*$ Standard deviation of the NPV

Additional information:

$1.$ Our firm typically prefers projects with a payback of $3$ years or less.

$2.$ Projects $1$ and $3$ have non$-$conventional cash flows.

Appendix $1$:

$-30\%-20\%-10\%0\%10\%20\%30\%$

$$(150,000\mathrm{.}00)$

$$(100,000\mathrm{.}00)$

$$(50,000\mathrm{.}00)$

$$-$

$$50,000\mathrm{.}00$

$$100,000\mathrm{.}00$

$$150,000\mathrm{.}00$

$$200,000\mathrm{.}00$

$$250,000\mathrm{.}00$

Sensitivity Analysis

Sales Price

VC per unit

salvage Value

WACC

Unit sales

NPV

PVs

Percent

Deviation Sales Price Cost per unit Unit sales Salvage Value WACC

$-30\%$ $ $(99,535\mathrm{.}00)$ $ $121,089\mathrm{.}00$ $ $(25,201\mathrm{.}00)$ $ $42,912\mathrm{.}00$ $ $70,423\mathrm{.}00$

$-20\%$ $ $(50,772\mathrm{.}00)$ $ $96,311\mathrm{.}00$ $ $(1,216\mathrm{.}00)$ $ $44,193\mathrm{.}00$ $ $62,238\mathrm{.}00$

$-10\%$ $ $(2,008\mathrm{.}00)$ $ $71,532\mathrm{.}00$ $ $22,769\mathrm{.}00$ $ $45,474\mathrm{.}00$ $ $54,354\mathrm{.}00$

Base Case $0\%$ $ $46,754\mathrm{.}00$ $ $46,754\mathrm{.}00$ $ $46,754\mathrm{.}00$ $ $46,754\mathrm{.}00$ $ $46,754\mathrm{.}00$

$10\%$ $ $95,518\mathrm{.}00$ $ $21,976\mathrm{.}00$ $ $70,740\mathrm{.}00$ $ $48,035\mathrm{.}00$ $ $39,428\mathrm{.}00$

$20\%$ $ $144,281\mathrm{.}00$ $ $(2,802\mathrm{.}00)$ $ $94,724\mathrm{.}00$ $ $49,316\mathrm{.}00$ $ $32,360\mathrm{.}00$

$30\%$ $ $193,044\mathrm{.}00$ $ $(27,580\mathrm{.}00)$ $ $118,710\mathrm{.}00$ $ $50,596\mathrm{.}00$ $ $25,541\mathrm{.}00$

Range

Appendix $2$:

$($In thousands$)$

Scenario Probability NPV

Best Case $30\%$ $$96\mathrm{.}31$

Base Case $60\%46\mathrm{.}754$

Worst Case $10\%$ $$(2\mathrm{.}27)$

E$($NPV$)$

Standard

Deviation

Coefficient of Variation