Investment Performance Measurements - Assignment Example

The paper "Investment Performance Measurements" is a wonderful example of an assignment on finance and accounting.

Company

Equity market value

Beta

ABC

2billion

1.50

XYZ

1billion

1.30

New capital structure

2billion

2.80

The net worth of the company will remain two billion since one billion dollars will be used to acquire XYZ

Question one (b)

Company

Equity market value

Beta

ABC

2billion

1.50

XYZ

1billion

1.30

Debt equity

1billion

New capital structure

3billion

2.80

There will be a creation of debt capital of one billion dollars whereas the other two billion will remain intact (Alberts & Segall, 2003).

Question one (c)

The cost of equity before acquisition

60% of 1,000,000 = 600M

The cost of equity after acquisition:

65% of 1,000,000,000 = 650M

With debt:

600m ×2 = 1.2 Billion dollars

650m ×2 = 1.3billion dollars

Question Two

Machine A

Investment cost-$500

Expected lifetime-3 years

Annual maintenance -$120

Machine B

Investment cost-$600

Expected lifetime-4 years

Annual maintenance -$100

Assuming that the cost of capital is 10%

Machine A – 500/A3, 10 = 500/2.48685 = 201.1

Machine B – 600/A4, 10 = 600/3.16987 = 189.28

The club should choose machine B since it has a lower EAC (Graham & Harvey, 2001).

Question Three

• Net Present Value

Space Plane NPV = 1000000/ (1.1)1 +1000000/ (1.1)2-1000, 000

Space Plane NPV = (909090.91+826446.28)-1000, 000 = 735,537.19

Space Plane project is acceptable since its NPV is greater than 1

Mars Shuttle NPV =1,000,000/ (1.1)1 + 1,000,000/ (1.1)2 + 1,000,000/ (1.1)3 – 2,000,000

Mars Shuttle NPV = 909090.91+826446.28+75314.80) - 2,000,000

Mars Shuttle NPV = 1,810,851.99-2,000,000 = -189,148.01

Mars Shuttle project should be rejected because its NPV is less than one

Venus Satellite NPV = 4,000,000/ (1.1)1-3000, 000

Venus Satellite NPV = 3636363.63-3,000,000 = 636,363.63

Venus Satellite project is acceptable since its NPV is greater than one

Moon Plant NPV = 900,000/ (1.1)1+900,000/ (1.1)2+900,000(1.1)3-1,500,000

Moon Plant NPV = (818,181.82+743,801.65+676,183.32)-1,500,000

Moon Plant NPV = 2,238,166.79-1,500,000 = 738,166.79

Moon Plant project should be acceptable since its NPV is greater than one (Schafrick, 2003).

Project

NPV

Rank

Moon Plant

738,166.79

1

Space Plane

735,537.19

2

Venus Satellite

636,363.63

3

• Internal Rate of Return

Space Plane IRR

0 = -1,000,000 + 1,000,000/ (1+IRR) 1+1,000,000/ (1+IRR) 2

= 0.10 = 10%

Mars Shuttle IRR

0 = -2,000,000+ 1,000,000/ (1+IRR) 1+1,000,000/ (1+IRR) 2+1,000,000/ (1+IRR) 3

=0.0235 = 2.35%

The project should be rejected because its IRR is lower than the required rate of return

Venus shuttle IRR

0 = -3,000,000+4,000,000/(1+IRR)1

IRR = 0.333 =33.3%

The projected should be accepted because its IRR is more than the required rate of return (Quiry et al, 2011).

Moon Plant IRR

0 = -1,500,000+900,000/(1+IRR)1+900,000/(1+IRR)2+900,000/(1+IRR)3

0.3446 = 34.5%

The project should be accepted since its IRR is greater than the required rate return (Hirschey, 2008).

• Payback period

Space Plane Payback period = 1,000,000÷1,000,000 = 1 Year

Mars Shuttle Payback period = 2,000,000÷1,000,000= 2 years

Venus shuttle Payback period = 3,000,000÷4,000,000 =0.75 years (9months)

Moon Plant Payback period = 1,500,000÷900,000 = 1.67Years (1 year, 8moths) (Greenwood, 2002).

Project

Payback period

Rank

Venus Satellite

9 months

1

Space Plane

1 year

2

Moon Plant

1 year 8 months

3

Mars Shuttle

2 years

4

• Profitability Index

Profitability Index = (NPV + Initial investment)/Initial investment

Space Plane PI = (735,537.19+1,000,000) /1,000,000

Space Plane PI = 1.74

The project should be accepted since PI is greater than one

Mars shuttle PI = (-189,148.01+2,000,000)/2,000,000

Mars shuttle PI = 0.91

The project has to be rejected because PI is less than one

Venus Satellite PI = (636,363.63+3,000,000)/ 3,000,000

Venus Satellite PI = 1.21

Moon Plant PI = (738,166.79+1,500,000)/1,500,000

Moon Plant PI = 1.49

Project

PI

Rank

Space Plane

1.74

1

Moon Plant

1.49

2

Venus Satellite

1.21

3

• Differences in acceptability and ranking

NPV and Profitability index both reject Mars Shuttle as a project since it does give a negative NPV and a profitability index of less than one. Using the payback period Mars Shuttle is ranked last. All projects indicate that Mars shuttle is not a viable or feasible project that Johnson Spacecraft have to avoid at all cost. Moon Plant project is ranked first using NPV, second using PI, and third using the payback period. The internal rate of return gives similar results as the payback period and NPV since they have rejected Mars Shuttle as a project (Feibel, 2003).  The differences in ranking of the projects happen with regard to what is considered in the calculations. NPV and PI have almost the same ranking since PI involves the use of NPV in its calculation. Differences in ranking depend on what is factored in during the calculation of the present value or the internal rate of return.