a.Value of shares = 30,000,000 * $ 42 = $
Computation of weighted average cost of capital of CWC (Magni 2015)
Cost of equity –
Ke = Rf + β (Rm – Rf)
Where,
Ke = cost of equity
Rf = Risk free rate = 3.5%
Β = Beta = 2.639
Rm = Market return = 12.52%
Therefore,
Ke = 3.5 + 2.639 * (12.52 – 3.5)
= 3.5 + 23.8038 = 27.3038%
Therefore, Ke or cost of equity = 27.3038%
Cost of bond –
Annual interest rate = 10% * 2 = 20%
Maturity = 20 years
Present value = 50,00,000 * $ 92.34 = $ 46,17,00,000
Face value = 50,00,000 * 100 = 50,00,00,000
Interest per year = 50,00,00,000 * 20% = $ 10,00,00,000
After tax interest = $ 10,00,00,000 * (1-0.34) = $ 660,00,000
Therefore, the effective rate = $ 660,00,000 / $ 50,00,00,000 = 0.132 or 13.20%
Cost of capital –
|
Amount |
Weightage |
Costs |
Weightage * Costs |
|
|
Ordinary shares |
1,260,000,000.00 |
0.7318 |
0.273 |
0.1998 |
|
Bonds |
461,700,000.00 |
0.2682 |
0.132 |
0.0354 |
|
Total |
1,721,700,000.00 |
1.0000 |
0.2352 |
Hence, weighted average cost of capital = 23.52%
b.Computation of depreciation –
Value of project = $ 30,00,000
Salvage value = Nil
Useful life = 3 years
Depreciation method = Straight line
Therefore, depreciation = $ 30,00,000 / 3 = $ 10,00,000 per year
|
Computation of cash flow |
||
|
Particulars |
Units |
Amount |
|
Sales (units) |
1250000 |
|
|
Sales revenue (p.u) |
$ 1.25 |
|
|
Total sales revenue |
$ 1,562,500.00 |
|
|
Variable cost (p.u) |
$ 0.24 |
|
|
Total variable cost |
$ 300,000.00 |
|
|
Contribution |
$ 1,262,500.00 |
|
|
Less: Fixed cost |
$ 200,000.00 |
|
|
Net income before tax |
$ 1,062,500.00 |
|
|
Less tax @ 34% |
$ 361,250.00 |
|
|
Net income after tax |
$ 701,250.00 |
|
|
Add: Depreciation |
$ 1,000,000.00 |
|
|
Cash flow |
$ 1,701,250.00 |
|
Calculation of NPV |
|||
|
Year 1 |
Year 2 |
Year 3 |
|
|
Cash flows before tax |
$ 1,062,500.00 |
$ 1,062,500.00 |
$ 1,062,500.00 |
|
Depreciation |
$ 1,000,000.00 |
$ 1,000,000.00 |
$ 1,000,000.00 |
|
Income before taxes |
$ 62,500.00 |
$ 62,500.00 |
$ 62,500.00 |
|
Taxes @ 34% |
$ 21,250.00 |
$ 21,250.00 |
$ 21,250.00 |
|
Net income after tax |
$ 41,250.00 |
$ 41,250.00 |
$ 41,250.00 |
|
Add: Depreciation |
$ 1,000,000.00 |
$ 1,000,000.00 |
$ 1,000,000.00 |
|
Cash flow after tax |
$ 1,041,250.00 |
$ 1,041,250.00 |
$ 1,041,250.00 |
|
After tax Terminal value |
$ 330,000.00 |
||
|
Net cash flow after tax |
$ 1,041,250.00 |
$ 1,041,250.00 |
$ 1,371,250.00 |
|
Discount rate @ 23.52% |
0.810 |
0.656 |
0.531 |
|
Present value of cash flows |
$ 843,117.41 |
$ 682,686.16 |
$ 727,973.83 |
|
Total |
$ 2,253,777.40 |
Net present value –
= Present value of cash flows – Initial investment
= $ 22,53,770.40 – $ 30,00,000 = – $ 746,222.60
It can be seen from the above calculation that the resultant NPV of project is in negative that is – $ 746,222.60 (Žižlavský 2014). Therefore, CWC shall not accept the proposed project of bottled water as per previously stated normal condition.
c.Best – case scenario
|
Calculation of cash flow |
||
|
Particulars |
Units |
Amount |
|
Sales (units) |
2,500,000.00 |
|
|
Sales revenue (p.u) |
$ 1.24 |
|
|
Total sales revenue |
$ 3,100,000.00 |
|
|
Variable cost (p.u) |
$ 0.22 |
|
|
Total variable cost |
$ 550,000.00 |
|
|
Contribution |
$ 2,550,000.00 |
|
|
Less: Fixed cost |
$ 200,000.00 |
|
|
Net income before tax |
$ 2,350,000.00 |
|
Calculation of NPV |
|||
|
Year 1 |
Year 2 |
Year 3 |
|
|
Cash flows before tax |
$ 2,350,000.00 |
$ 2,350,000.00 |
$ 2,350,000.00 |
|
Depreciation |
$ 1,000,000.00 |
$ 1,000,000.00 |
$ 1,000,000.00 |
|
Income before taxes |
$ 1,350,000.00 |
$ 1,350,000.00 |
$ 1,350,000.00 |
|
Taxes @ 34% |
$ 459,000.00 |
$ 459,000.00 |
$ 459,000.00 |
|
Net income after tax |
$ 891,000.00 |
$ 891,000.00 |
$ 891,000.00 |
|
Add: Depreciation |
$ 1,000,000.00 |
$ 1,000,000.00 |
$ 1,000,000.00 |
|
Cash flow after tax |
$ 1,891,000.00 |
$ 1,891,000.00 |
$ 1,891,000.00 |
|
Terminal value |
$ 330,000.00 |
||
|
Net cash flow after tax |
$ 1,891,000.00 |
$ 1,891,000.00 |
$ 2,221,000.00 |
|
Discount rate @ 23.52% |
0.810 |
0.656 |
0.531 |
|
Present value of cash flows |
$ 1,531,174.09 |
$ 1,239,817.08 |
$ 1,179,091.98 |
|
Total |
$ 3,950,083.15 |
Net present value –
= Present value of cash flows – Initial investment
= $ 39,50,083.15 – $ 30,00,000 = $ 950,083.15
It can be seen from the above calculation that the resultant NPV of project is positive that is $ 950,083.15. Therefore, CWC shall accept the proposed project of bottled water as per best case scenario.
Worst – case scenario
|
Calculation of cash flow |
||
|
Particulars |
Units |
Amount |
|
Sales (units) |
950,000.00 |
|
|
Sales revenue (p.u) |
$ 1.32 |
|
|
Total sales revenue |
$ 1,254,000.00 |
|
|
Variable cost (p.u) |
$ 0.27 |
|
|
Total variable cost |
$ 256,500.00 |
|
|
Contribution |
$ 997,500.00 |
|
|
Less: Fixed cost |
$ 200,000.00 |
|
|
Net income before tax |
$ 797,500.00 |
|
Calculation of NPV |
|||
|
Year 1 |
Year 2 |
Year 3 |
|
|
Cash flows before tax |
$ 797,500.00 |
$ 797,500.00 |
$ 797,500.00 |
|
Depreciation |
$ 1,000,000.00 |
$ 1,000,000.00 |
$ 1,000,000.00 |
|
Income before taxes |
$ (202,500.00) |
$ (202,500.00) |
$ (202,500.00) |
|
Taxes @ 34% |
$ (68,850.00) |
$ (68,850.00) |
$ (68,850.00) |
|
Net income after tax |
$ (133,650.00) |
$ (133,650.00) |
$ (133,650.00) |
|
Add: Depreciation |
$ 1,000,000.00 |
$ 1,000,000.00 |
$ 1,000,000.00 |
|
Cash flow after tax |
$ 866,350.00 |
$ 866,350.00 |
$ 866,350.00 |
|
Terminal value |
$ 330,000.00 |
||
|
Net cash flow after tax |
$ 866,350.00 |
$ 866,350.00 |
$ 1,196,350.00 |
|
Discount rate @ 23.52% |
0.810 |
0.656 |
0.531 |
|
Present value of cash flows |
$ 701,497.98 |
$ 568,014.56 |
$ 635,122.33 |
|
Total |
$ 1,904,634.86 |
Net present value –
= Present value of cash flows – Initial investment
= $ 19,04,634.86 – $ 30,00,000 = – $ 10,95,365.15
It can be seen from the above calculation that the resultant NPV of project is in negative that is – $ 10,95,365.15. Therefore, CWC shall not accept the proposed project of bottled water as per worst case scenario.
d.As the financial analyst, before providing any suggestions the analyst shall gain complete knowledge of the client’s business, their preference and requirements. Further, he shall arrange a meeting with the concerned person to explain the brief idea regarding net present value and associated factors. Moreover, he shall go through the last year’s financial records and the projected budget to analyse the sales level and cash flow (Lee and Lee 2015).
The NPV is the difference among the present value of the cash inflows and outflows over the specific period of the time. It is used under capital budgeting for analyzing the profitability of project or investment in a project. If the NPV of the project is positive it indicates that the earnings created from the investment exceeds the projected costs. Generally a project with positive NPV is regarded as profitable and with negative NPV is regarded as the project that will generate loss. This is the basic rule for NPV that states that the investment shall be made with the project only that has positive NPV (Pasqual, Padilla and Jadotte 2013). It takes into consideration the below mentioned 2 inputs –
Further, it takes into account the time value of money that makes it better approach for the technique of investment appraisal as compared to other methods like IRR.
Taking into consideration the above presented computations, it is observed that the resultant NPV of project is positive that is $ 950,083.15 only under best case scenario. The NPV under current scenario as well under worst case scenario is negative. Therefore, CWC shall accept the proposed project of bottled water under best case scenario only.
References
Lee, I. and Lee, K., 2015. The Internet of Things (IoT): Applications, investments, and challenges for enterprises. Business Horizons, 58(4), pp.431-440.
Magni, C.A., 2015. Investment, financing and the role of ROA and WACC in value creation. European Journal of Operational Research, 244(3), pp.855-866.
Pasqual, J., Padilla, E. and Jadotte, E., 2013. Equivalence of different profitability criteria with the net present value. International Journal of Production Economics, 142(1), pp.205-210.
Žižlavský, O., 2014. Net present value approach: method for economic assessment of innovation projects. Procedia-Social and Behavioral Sciences, 156, pp.506-512.
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