The main purpose of this assessment is to analyze the business of Tastegood ltd which is planning to enter into an agreement to supply its confectionery in a private label to Cheap & Good which is a supermarket chain. This agreement is anticipated to increase the production requirement of the business and also the earning capacity of the business. The assessment analyses two different scenarios which is anticipated by the business of Tastegood ltd and on the basis of the results of the analysis decisions regarding whether to accept the proposal or not. Another part of the assessment considers the stock price returns of the business of Tastegood ltd and whether the same are consistent with the analysis which is conducted in the first part. The second part analysis the abnormal returns of the business and how the business can take advantage of the same (Hirshleifer, Hsu and Li 2013). The stock prices which are provided are to be analyzed on the basis of returns generated from the same.
As per the situation, Tastegood ltd is planning to enter into an agreement for supply of confectionery products to Cheap & Good Supermarket chain and the management of the company anticipated two scenarios where in the incremental revenue of the business will be 40% lower for, year six onwards and the second scenario anticipates that the incremental revenue would be 20% higher from year six onwards. The analysis is considered for a period of 10 years in order to derive appropriate data from the analysis for the purpose of taking decisions.
In order to meet the production requirements under the proposal. The business would be needing to set up a new machinery which is anticipated to cost $ 2,600,000 with an installation charges of $ 200,000. The depreciation on the machinery is charged on written down value method over the period of 10 years. As per the case, which is presented in Scenario 1, the net incremental earnings for the first year is shown to be in negative which gradually improves from the second year as shown in the table 1 presented in Appendix section. As per Scenario 1, the incremental earnings of the business are anticipated to fall from the 6th year as per the anticipation of the management. The net cash flows of the business are shown to be have fallen drastically in case of this scenario (Cakici, Fabozzi and Tan 2013). The net cash flows are shown to be positive for all the years except the first year which is a positive sign for the business. On the basis of the cash inflows which is computed under the Scenario 1, the NPV for the proposal is computed and the same show negative results which is shown to be $ 464,882. The proposal is not shown to be favorable under this scenario as the NPV is shown to be negative which shows that the project would not be profitable under this scenario (Mer?o 2013). On the other hand, the IRR of the project, Profitability is shown to be favorable which is a good sign. The payback period analysis shows that it would take 7.33 years to cover the outflows of the projects.
Under this Scenario, the management of Tastegood ltd anticipates that the incremental revenue which is generated by the business would further increase from 6th year onwards by 20%. This is a situation where the management anticipates that the project would be a success and the same would enhance in later years. The investments which is made by the business in machinery is same and the initial outflow is also similar. The incremental revenue which is generated by the business is shown to be on a constant rise from year 6 onwards and this indicates further success in the business of Tastegood ltd. The net cash flows are shown to be positive for all the 10 years and the same is shown to be on the rise from year 6 onwards. The NPV which is computed on the basis of the estimated net cash flow is shown to be $ 355,238 which is a positive figure and signifies that the project has the potential to earn significant amount of profits for the business in future. The other standards such as profitability index, IRR and payback period of the project under this scenario is also shown to be favorable which shows that the project is worth making investment (Bas 2013). The payback period which is computed under this scenario is shown to be 6.14 years which has reduced significantly which shows a favorable sign for the business.
On a normal circumstance also, the project shows a positive NPV which is a clear sign that the proposal is viable for business point of view. It is to be noted that the computation of the NPV is done considering the discounting rate of 11.5388% for which the computation is shown in Table 4 in Appendix. The computation shows that return factors such as market rate of return, stock return is considered and also significant computation is also shown for the same in the appendix section. In addition to this, there are also further assumptions taken for the purpose of investment appraisal of the projects which the business of Tastegood ltd is considering such as the revenue which is generated from the business is on an assumption basis and also the scenario which is considered are also on the estimation basis which is largely depended on the market and other factors which affect the revenue generating capabilities of the business (Azzheurova and Bessonova 2015). In addition to this, it is also assumed that no major fluctuation takes place in the stocks prices of the business.
Thus, from the discussion which is shown above, the management of Tastegood ltd should proceed forward with the proposal of supply of confectionery products to Cheap & Good Supermarket chain. The project is shown to be favourable in normal situation and also in scenario 2 while the management needs to avoid scenario 1 which is also a probability. In Scenario 1, the project would not be profitable and the business can incur significant losses and therefore the management needs to consider this probability as well in decision making process.
The abnormal returns of the business reveal the return which a business earns above the expected return of the business. The table which is portrayed in the appendix section clearly shows that the business starts to earn abnormal returns 1 day before the announcement of the proposal of the business (Mallikarjunappa and Dsouza 2013). After the announcement, the returns which is generated by the business is much more than the expected return which is anticipated by the business which shows significant abnormal returns for the business (Degutis and Novickyt? 2014). The stock prices of the business are affected by the announcement of the proposal of the business which effectively shows that the stock prices clearly demonstrate the stock prices effectively reflects all public information (Rizvi et al. 2014). Therefore, it can be said that the stock prices of the business are consistent with the semi-strong form of market efficiency as the stock prices adjust quickly with the announcement of the business plan of the Tastegood ltd.
As per the analysis which is shown in Part 1, the management of the company had anticipated that the new proposal of supplying confectionery products to Cheap & Good Supermarket chain would result in an increase surge of demands for the products of Tastegood ltd and therefore the management of the company installed new machinery to meet the demand. The management of the company also anticipated that the cash inflows would increase and so will the profitability of the business (Hirshleifer, Hsu and Li 2013). Therefore, the stock returns of the business is anticipated to increase and therefore the abnormal returns confirm with the analysis which is conducted in Part 1.
On the basis of the increase in the returns of the business, the management of the company needs to issue more stock in order to raise more capital and increase the shareholders base which can result in growth in the operations of the business (Bessembinder and Zhang 2013). The management also can take advantage of the market valuation in order to enter new contracts and further expand the business. As the event window closes, the return on stock would also fall from abnormal returns and be more like normal returns from the stocks of the business. The return on stock would stabilize as the event window closes.
Conclusion
The above discussion clearly shows that the management should move forward with its plan of supplying confectionery products to Cheap & Good Supermarket chain as the same results in more profitability for the business and also the business able to generate abnormal return on stock which forward reflect the performance of the business. The second part also shows that the return which is generated by the business is consistent with semi-strong form of market efficiency.
Reference
Azzheurova, K.E. and Bessonova, E.A., 2015. Development of methods for analysis and assessment of the efficiency of regional investment projects seeking state support. Mediterranean Journal of Social Sciences, 6(5), p.362.
Bas, E., 2013. A robust approach to the decision rules of NPV and IRR for simple projects. Applied Mathematics and Computation, 219(11), pp.5901-5908.
Bessembinder, H. and Zhang, F., 2013. Firm characteristics and long-run stock returns after corporate events. Journal of Financial Economics, 109(1), pp.83-102.
Cakici, N., Fabozzi, F.J. and Tan, S., 2013. Size, value, and momentum in emerging market stock returns. Emerging Markets Review, 16, pp.46-65.
Degutis, A. and Novickyt?, L., 2014. The efficient market hypothesis: a critical review of literature and methodology. Ekonomika, 93(2).
Hirshleifer, D., Hsu, P.H. and Li, D., 2013. Innovative efficiency and stock returns. Journal of Financial Economics, 107(3), pp.632-654.
Mallikarjunappa, T. and Dsouza, J.J., 2013. A Study of Semi-Strong Form of Market Efficiency of Indian Stock Market. Amity Global Business Review, 8.
Mer?o, P., 2013. Implications of discounting methods and relations between NPV, IRR and MIRR for efficiency evaluation of investment projects. Humanities and Social Sciences 2013, p.103.
Rizvi, S.A.R., Dewandaru, G., Bacha, O.I. and Masih, M., 2014. An analysis of stock market efficiency: Developed vs Islamic stock markets using MF-DFA. Physica A: Statistical Mechanics and its Applications, 407, pp.86-99.
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