Theory and Problems in Financial Management - Assignment Example

The paper 'Theory and Problems in Financial Management' is a wonderful example of a Finance and Accounting Assignment. WACC is an appropriate method of evaluating projects bearing in mind that companies finance is through either Equity or Debt, hence getting an average of the two sources of funding through weightage represents the true view of capital structure (Fama, 1968; Khan, 1993). This will enable management to determine the economic feasibility of projects to be undertaken as companies expect certain returns from every dollar invested.

• Calculation of the Net Present Value of the project. (Rounded to the nearest dollar)

The following data was used to evaluate the project to purchase new equipment as shown in table 1.1 below.

Table 1.1: Project data

 

Year 0

$

Year 1

$

Year 2

$

Year 3

$

Year 4

$

Cash flows

(17,000)

13,900

13,066

12,282

11,545

Cost of operations

 

2,700

2,700

2,700

2,700

Maintenance

 

1,100

1,300

1,500

1,700

Cash flows

 

17,700

17,066

16,482

15,945

Scrap Value

 

 

 

 

3,000

Additional Working Capital Recovered

 

 

 

 

1,300

Actual Cash flows

 

17,700

17,066

16,482

17,645

Cumulative Cash flows

 

17,700

34,766

51,248

68,893

Calculating interim incremental Net Cash Flows we get the results shown in table 1.2 below.

Table 1.2: Incremental Net Cash Flows

 

End of year

 

 

 

 

1

2

3

4

Net operating revenue

17,700

17,066

16,482

17,645

Less foregone rent revenue

2,000

2,000

2,000

2,000

Less Depreciation

4,250

4,250

4,250

4,250

The net change in income BT

11,450

10,816

10,232

11,395

Tax

3,435

3,245

3,070

3,419

The net change in income after tax

8,015

7,571

7,162

7,977

The terminal incremental net cash flow for terminal year 4 includes salvage value of fewer taxes due to the sale of the asset.

The expected incremental net cash flows from the project are:

Table 1.3: Project cash flows

 

End of year

 

 

 

 

 

0

1

2

3

4

Net cash flows

(17,000)

8,015

7,571

7,162

7,977

Using discounted cash flow method (NPV) to evaluate project feasibility, we used the formula: NPV = ∑ [Ct/{1+k}^t]-Io where;

C= cash flow at the end of year

K= required rate of return

Io= initial cost of the project

With t=1 to t=4 i.e. n=4 (project life)

The decision will be based on accepting the project if NPV > 0.

Table 1.4: NPV

year

Cash flow

PDF (13.77%)

Present Values

0

(17,000)

1

(17,000)

1

8,015

0.87896634

7,045

2

7,571

0.77258182

5,849

3

7,162

0.67907341

4,864

4

7,977

0.59688267

4,761

 

 

Total PVs

22,519

 

 

Less Io

17000

 

 

NPV

5,519

• Recommendation as to whether or not the project should proceed.

West Coast Manufacturing Company Ltd. should invest in the project as it has a positive NPV of $5,519 which means it will add value to company assets.

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