Catanza Technologies was formed in Brisbane in year 2002 at Eagle farm. It has its specialised knowledge in industrial sensor technology. The company expanded its operation in year 2004 and come up with an idea of commercial grade robotic floor cleaner which had a steady revenue growth and market share. The company generates major revenue from industrial sensor product.
Company has come up with an idea to develop a commercial robotic lawn management tools and equipment. A research analysis was conducted in year 2015-16 and the outcome was that customer take decision in this market on basis of mowing area per day on basis of running time per charge and battery charging time, navigation precision, programming ease, uneven surfaces adaptability.
On basis of available information, the company is planning to develop a production prototype on basis of two different approaches. Electric wire and Sensing navigation. The GPS model is more versatile as compared to other model and also suited to larger part of area of up to 12000 sqm per day.
It is expected for EW protype model that there is a 75% chance that a December month end target could be achieved, if not than the entire project might be abandoned or further work shall be carried out. To carry the whole modification process, it would cost around $0.8 million and will take additional six-month sot execute the same. However, it is ascertained that the entire problem would be solved by month end June 2020.
It is expected for GPS protype model that there is a 60% chance that a December month end target could be achieved, if not than the entire project might be abandoned or further work shall be carried out. To carry the whole modification process, it would cost around $1.9 million and will take additional twelve months to execute the same. However, it is ascertained that the entire problem would be solved by out. month end December 2020.
In order to successfully develop the product, the production process will be carried in partner facilities in China. Six- and twelve-months’ time frame shall be required for the entire solution process.
Catanza Technologies can commence production in July 2020 after successful development of EW prototype. If further work needs to be done than production shall begin in January 2021. The sales price for same shall be around in range $3500 and $4500.For GPS prototype production shall begin in January 2021.If development process is required to be done for this prototype than production shall start until January 2022. The sales price for same shall be around in range $14000 and $ 16000.
In order to simplify the situation, the company management has decided to classify the same under two different market scenarios Good and Poor. There is an estimated probability and same shall prevail if on how quickly the product can be launched to the market and company can also gain an edge over its competitors.
In case the development of any prototype is being cancelled than the intellectual property will have no residual value involved.
A DCF model is a Financial Modelling Tool which is used to ascertain the business value. It stands for discounted cash flow .It is used to predict company unlevered free cash flow which is discounted to today present value ,which is known as Net Present Value . (CFI Education Inc., 2022)Through this valuation method the value if an investment is ascertained on basis of expected future cash flows involved .It attempts to figure out the investment value today ,on basis of projection of how much money will be formed in future course of time. (Wall Street Prep, Inc, 2022)
NPV analysis is used to ascertain all the future cash flows over the whole life of an investment which is discounted to the present value form. It is a form of intrinsic valuation which is used to ascertain the business value, security value of investment, capital project and any form of value which involves cash flow. (CFI Education Inc., 2022)
The cash flow value is discounted due to two reasons involved:
Risk adjustment in a project is very much important as all projects do not carry a same level of risk. For a riskier project the discount rate considered is very much high and lower for the safer project in hand.
Time value of money factor is considered due to inflationary factors, rate of interest and involved opportunity cost, money value is considered more valuable the sooner it is realised from an investment value. (cleartax.in, 2021)
It is the most powerful tool for the purpose of classification and prediction. The same is used visually and explicitly represent decision and also decision making. It is used like a tree model of decisions. (Gupta, 2017)It is very much helpful to form basic understandable rules involved and calculations are performed without involvement of computation. Both continuous and categorical variables are handled with the help of this tool.
There are few limitations involved of this analysis:
Risk neutral probability is one of the crucial element in determining the expected cash flow as decision tree involves estimation of a particular path based on the probability of direction of such move. The probability model helps to compute the expected value of the path or trajectory and whether the node is profitable or not. It is based on principal of rationality and helps to make decision making under decision tree easy and quick.
The estimated cost of capital is 8%. All the cash flow will be occurred at the end of year. All involved factors like taxation and development grants need to be ignored. Further, the model assumes that there is no other cost other than cost of manufacturing and further testing. Also, the cost already incurred which stands at $ 1.65 Million is a sunk cost and the cost is not relevant for the purpose of analysis. The analysis has been made on the principal of relevant cost and revenue. The key points of assumptions has been presented as under:
The analysis for EV Model has been presented as under:
The company is standing at January 2019 and has to take decision whether it shall further expend or stop right now whereby the already expenditure incurred shall be loss for the company. The said action shall result in loss of $1.65 Million. This node shall originate form start and indicate a loss cash flow. Accordingly, the company at present has two option i.e. to continue or stop.
Further, once the company selects the continue model then two nodes shall originate from the continue point containing the following data. For the EW prototype, the company’s chief engineer, Scott Shorten, has estimated that there is a 75% chance that the December target could be achieved for the EW model with a further investment of $1.75m. Thus, there is 25% probability of not achieving the target.
Also, in case of failure company has two options to review the situation in January 2020 and in such case company can decide to either stop the activity and book loss or expend further to complete the model by June 2020. The facts are as under: If the target is not achieved, the company will review the situation in January 2020. It could decide to abandon the entire project or to allow further work on the prototype. Shorten estimates that modification of an unsuccessful prototype would cost around $0.8 million and the modifications would take an additional six months to implement. He is, however, sure that all problems would be overcome by end June 2020.
The above facts have been explained diagrammatically as under:
Based on said facts, financial cash flow model has been computed with 2 situations where in company achieves success in one chance and in other case in second chance. It shall not be pragmatic for the company to discontinue production/ testing as dropping the project shall result in loss only. The computation of cash flow under 75% success node has been presented as under:
|
Cash flow from July 2020 Production |
|||||||
|
Probability |
|||||||
|
Good |
Poor |
Good |
Poor |
Cash flow |
DF |
PV |
|
|
Jan-19 |
-1.75 |
1 |
-1.75 |
||||
|
Jan-20 |
-1.25 |
0.925926 |
-1.15741 |
||||
|
Jan-21 |
0 |
0.857339 |
0 |
||||
|
Jul-21 |
6 |
2 |
0.8 |
0.2 |
5.2 |
0.824364 |
4.286694 |
|
Jul-22 |
9 |
4 |
0.8 |
0.2 |
8 |
0.7633 |
6.106402 |
|
Jul-23 |
12 |
6 |
0.8 |
0.2 |
10.8 |
0.706759 |
7.633002 |
|
Jul-24 |
16 |
7 |
0.8 |
0.2 |
14.2 |
0.654407 |
9.292578 |
|
Jul-25 |
19 |
9 |
0.8 |
0.2 |
17 |
0.605932 |
10.30085 |
|
Expected Value |
34.71212 |
Based on above table, it may be seen that company shall expend 1.75 Million in January 2019 and 1.25 Million in January 2020 under success case. Further, these cash flow shall be discounted at the rate of 8%. Also, the cash flow shall originate from the business from July 2021 as cash flow shall accrue at the end of the year. The cash flow shall be for period of 5 years and there shall be two situation namely good and poor. The diagrammatic presentation of good and poor case is as under:
Based on above computation, the value of success node has been computed at 34.71 Million.
In case of failure situation, the cash flow has been presented as under:
|
Cash flow from Jan 2021 Production |
|||||||
|
Probability |
|||||||
|
Good |
Poor |
Good |
Poor |
Cashflow |
DF |
PV |
|
|
Jan-19 |
-1.75 |
1 |
-1.75 |
||||
|
Jan-20 |
-0.8 |
0.925926 |
-0.74074 |
||||
|
Jan-21 |
-1.25 |
0.857339 |
-1.07167 |
||||
|
Jul-21 |
0 |
0 |
|||||
|
Jan-22 |
6 |
2 |
0.65 |
0.35 |
4.6 |
0.793832 |
3.651628 |
|
Jan-23 |
9 |
4 |
0.65 |
0.35 |
7.25 |
0.73503 |
5.328966 |
|
Jan-24 |
12 |
6 |
0.65 |
0.35 |
9.9 |
0.680583 |
6.737774 |
|
Jan-25 |
16 |
7 |
0.65 |
0.35 |
12.85 |
0.63017 |
8.09768 |
|
Dec-25 |
18 |
9 |
0.65 |
0.35 |
14.85 |
0.58349 |
8.664832 |
|
Expected Value |
28.91847 |
Based on above table, it may be seen that company shall expend 1.75 Million in January 2019 and 0.8 Million in January 2020 under failure case. Also, the company shall expend further 1.25 Million in January 2021 for production. Further, these cash flow shall be discounted at the rate of 8%. Also, the cash flow shall originate from the business from Jan 2022 as cash flow shall accrue at the end of the year. The cash flow shall be for period of 5 years and there shall be two situation namely good and poor. The diagrammatic presentation of good and poor case is as under:
Based on above computation, the value of success node has been computed at 28.92 Million.
Thus, the net cash flow from the EV model based on NPV analysis has been presented as under:
|
Computation of Cash flow |
||||
|
Sl No |
Particular |
Probability |
Cash flow |
Expected Cashflow |
|
1 |
Production in July 2020 |
0.75 |
34.71212 |
26.03 |
|
2 |
Production in Jan 2021 |
0.25 |
28.91847 |
7.23 |
|
Expected Cash flow |
33.26 |
Based on above computation, it may be inferred that the cash flow from the EV project shall be 33.26 Million in case the project is continued and 0 Million in case the project is dropped. However, considering the rationality and pragmatic activity involved the project shall be executed and negative node shall be ignored.
The company is standing at January 2019 and has to take decision whether it shall further expend or stop right now whereby the already expenditure incurred shall be loss for the company. The said action shall result in loss of $1.65 Million. This node shall originate form start and indicate a loss cash flow. Accordingly, the company at present has two option i.e. to continue or stop.
Further, once the company selects the continue model then two nodes shall originate from the continue point containing the following data. For the GPS prototype, the company’s chief engineer, Scott Shorten, has estimated that there is a 60% chance that the December target could be achieved for the GPS model with a further investment of $3.3m. Thus, there is 40% probability of not achieving the target.
Also, in case of failure company has two options to review the situation in January 2020 and in such case company can decide to either stop the activity and book loss or expend further to complete the model by December 2020. The facts are as under: If the target is not achieved, the company will review the situation in January 2020. It could decide to abandon the entire project or to allow further work on the prototype. Shorten estimates that modification of an unsuccessful prototype would cost around $1.9 million and the modifications would take an additional year to implement. He is, however, sure that all problems would be overcome by end December 2020.
The above facts have been explained diagrammatically as under:
Based on said facts, financial cash flow model has been computed with 2 situations where in company achieves success in one chance and in other case in second chance. It shall not be pragmatic for the company to discontinue production/ testing as dropping the project shall result in loss only. The computation of cash flow under 60% success node has been presented as under:
|
Cash flow from Jan 2021 Production |
|||||||
|
Probability |
|||||||
|
Good |
Poor |
Good |
Poor |
Cash flow |
DF |
PV |
|
|
Jan-19 |
-3.3 |
1 |
-3.3 |
||||
|
Jan-20 |
-2.7 |
0.925926 |
-2.5 |
||||
|
Jan-21 |
0 |
0.857339 |
0 |
||||
|
Jul-21 |
0 |
0 |
|||||
|
Jan-22 |
10 |
4 |
0.65 |
0.35 |
7.9 |
0.793832 |
6.271275 |
|
Jan-23 |
16 |
7 |
0.65 |
0.35 |
12.85 |
0.73503 |
9.445134 |
|
Jan-24 |
18 |
9 |
0.65 |
0.35 |
14.85 |
0.680583 |
10.10666 |
|
Jan-25 |
22 |
11 |
0.65 |
0.35 |
18.15 |
0.63017 |
11.43758 |
|
Jan-26 |
26 |
13 |
0.65 |
0.35 |
21.45 |
0.58349 |
12.51587 |
|
Expected Value |
43.97652 |
Based on above table, it may be seen that company shall expend 3.3 Million in January 2019 and 2.7 Million in January 2020 under success case. Further, these cash flow shall be discounted at the rate of 8%. Also, the cash flow shall originate from the business from July 2021 as cash flow shall accrue at the end of the year. The cash flow shall be for period of 5 years and there shall be two situation namely good and poor. The diagrammatic presentation of good and poor case is as under:
Based on above computation, the value of success node has been computed at 43.98 Million.
In case of failure situation, the cash flow has been presented as under:
|
Cash flow from Jan 2022 Production |
|||||||
|
Probability |
|||||||
|
Good |
Poor |
Good |
Poor |
Cash flow |
DF |
PV |
|
|
Jan-19 |
-3.3 |
1 |
-3.3 |
||||
|
Jan-20 |
-1.9 |
0.925926 |
-1.75926 |
||||
|
Jan-21 |
0 |
0.857339 |
0 |
||||
|
Jul-21 |
0 |
0 |
|||||
|
Jan-22 |
-2.7 |
0.793832 |
-2.14335 |
||||
|
Jan-23 |
10 |
4 |
0.5 |
0.5 |
7 |
0.73503 |
5.145209 |
|
Jan-24 |
16 |
7 |
0.5 |
0.5 |
11.5 |
0.680583 |
7.826707 |
|
Jan-25 |
18 |
9 |
0.5 |
0.5 |
13.5 |
0.63017 |
8.50729 |
|
Jan-26 |
22 |
11 |
0.5 |
0.5 |
16.5 |
0.58349 |
9.627592 |
|
Expected Value |
23.90419 |
Based on above table, it may be seen that company shall expend 3.3 Million in January 2019 and 1.9 Million in January 2020 under failure case. Also, the company shall expend further 2.7 Million in January 2022 for production. Further, these cash flow shall be discounted at the rate of 8%. Also, the cash flow shall originate from the business from Jan 2023 as cash flow shall accrue at the end of the year. The cash flow shall be for period of 4 years and there shall be two situation namely good and poor. T
Based on above computation, the value of success node has been computed at 23.90 Million.
Thus, the net cash flow from the GPS model based on NPV analysis has been presented as under
|
Computation of Cash flow |
||||
|
Sl No |
Particular |
Probability |
Cash flow |
Expected Cash flow |
|
1 |
Production in Jan 2021 |
0.6 |
43.97652 |
26.39 |
|
2 |
Production in Jan 2022 |
0.4 |
23.90419 |
9.56 |
|
Expected Cash flow |
35.95 |
Sensitivity analysis has been carried out with respect to cost of capital to understand the impact on the cash flow for EV and GPS model. The computation has been presented as under:
|
EV Model- Sensitivity Analysis |
|
|
Discount Rate |
Expected Value |
|
8% |
33.26 |
|
5% |
38.77495261 |
|
6.00% |
36.82608843 |
|
7.00% |
34.99163237 |
|
8.00% |
33.26370565 |
|
9.00% |
31.63504715 |
|
10.00% |
30.09895939 |
|
11.00% |
28.64925972 |
|
12.00% |
27.28023617 |
|
13.00% |
25.98660741 |
Based on above computation, it may be inferred that model is still profitable despite such high change in cost of capital and there exists an inverse relationship between the cost of capital and the expected value of the project.
|
GPS Model- Sensitivity Analysis |
|
|
Discount Rate |
Expected Value |
|
8% |
35.95 |
|
5% |
42.82 |
|
6.00% |
40.38 |
|
7.00% |
38.09 |
|
8.00% |
35.95 |
|
9.00% |
33.93 |
|
10.00% |
32.04 |
|
11.00% |
30.26 |
|
12.00% |
28.59 |
|
13.00% |
27.01 |
Based on above computation, it may be inferred that model is still profitable despite such high change in cost of capital and there exists an inverse relationship between the cost of capital and the expected value of the project.
Thus, one may conclude the GPS model is higher capital intensive and has more positive NPV and Expected Value as compared to EV Model
Based on above discussion and analysis, it may be inferred that model GPS has higher NPV and Expected Value as compared to EV Model. Further both models are value additive and shall help in increasing the wealth of the shareholders of the company. These models shall help in making losses good and shall help the growth of the company. Hence the company should go for both the model and in case any choice is required to be made under difficult times than GPS model shall be preferred over other model as the model has higher NPV.
References
CFI Education Inc., 2022. DCF Model Training Free Guide. [Online]
Available at: https://corporatefinanceinstitute.com/resources/knowledge/modeling/dcf-model-training-free-guide/
[Accessed 3 March 2022].
CFI Education Inc., 2022. Net Present Value (NPV). [Online]
Available at: https://corporatefinanceinstitute.com/resources/knowledge/valuation/net-present-value-npv/
[Accessed 3 March 2022].
cleartax.in, 2021. NPV ( Net Present Value ) – Formula, Meaning & Calculator. [Online]
Available at: https://cleartax.in/s/npv-net-present-value
[Accessed 3 March 2022].
geeksforgeeks.org, 2021. Decision Tree. [Online]
Available at: https://www.geeksforgeeks.org/decision-tree/
[Accessed 3 March 2022].
Gupta, P., 2017. Decision Trees in Machine Learning. [Online]
Available at: https://towardsdatascience.com/decision-trees-in-machine-learning-641b9c4e8052
[Accessed 3 March 2022].
Wall Street Prep, Inc, 2022. DCF Model Training. [Online]
Available at: https://www.wallstreetprep.com/knowledge/dcf-model-training-6-steps-building-dcf-model-excel/
[Accessed 3 MAarch 2022].
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