Cost-Benefit Analysis

FINANCIAL MANAGEMENT – JWI530009JWONL-1184-001

Case Analysis 1

  1. If $300,000 was left in the bank for 5 years collection interest at 4% compounded annually, you would have $364,995.87 at the end of the 5 years.
A= Amount at the end of the period Calculated Manually Calculated with Excel
P = The amount deposited today A=P(1+R)^n =FV(4%,5,0,-300000)
R= Interest Rate $364,995.87
n= time in years A=300,000(1+.04)^5
A=300,000(1.04)^5
A=300,000(1.04)^5
A= 364,995.87

 

  1. “The payback period is the length of time required to recover the cost of an investment”(Payback Period, 2018). If we undertook the investment opportunity, using the nominal payback period calculation it would take 3 years to reach the payback period.
Year Projected Cash Flow Cumulative Cash Flows
1 $90,000.00 $90,000.00
2 $115,000.00 $205,000.00
3 $135,000.00 $340,000.00
4 $110,000.00 $450,000.00
5 $90,000.00 $540,000.00

 

  1. “A discounted payback period gives the number of years it takes to break even from undertaking the initial expenditure, by discounting future cash flows and recognizing the time value of money”(Discounted Payback Period, 2018). The discount payback period at a 7% rate will be 4 years.

 

Year Projected Cash Flow PV at 7% Discounted Amount Cumulative Cash Flows
1 $90,000.00 0.9346 $84,114.00 $84,114.00
2 $115,000.00 0.8734 $100,441.00 $184,555.00
3 $135,000.00 0.8163 $110,200.50 $294,755.50
4 $110,000.00 0.7629 $83,919.00 $378,674.50
5 $90,000.00 0.713 $64,161.00 $442,835.50

 

 

 

 

 

 

 

  1. “Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time”(Net Present Value – NPV, 2018). The Net present value of the investment opportunity at the end of the 5 years will be $442,835.50.

 

Year Projected Cash Flow PV at 7% Discounted Amount Cumulative Cash Flows
1 $90,000.00 0.9346 $84,114.00 $84,114.00
2 $115,000.00 0.8734 $100,441.00 $184,555.00
3 $135,000.00 0.8163 $110,200.50 $294,755.50
4 $110,000.00 0.7629 $83,919.00 $378,674.50
5 $90,000.00 0.7129 $64,161.00 $442,835.50

 

  1. When having the choice of either leaving the money in the savings account to collect 7% interest annually or investing in the opportunity, the investment would be the better choice. At the end of the 5 years with the savings account you will have $364,995.87 vs. the $442,835.50 you would have at the end of the 5 years with the investment. The investment would yield $77,839.63 more than the bank account. The only concern would be if the investments projected return dropped 18% or more that would cause the investment to have a lower cash flow than the bank account.

 

Year Projected Cash Flow less 18% PV at 7% Discounted Amount Cumulative Cash Flows
1 $73,800.00 0.9346 $68,973.48 $68,973.48
2 $94,300.00 0.8734 $82,361.62 $151,335.10
3 $110,700.00 0.8163 $90,364.41 $241,699.51
4 $90,200.00 0.7629 $68,813.58 $310,513.09
5 $73,800.00 0.7129 $52,612.02 $363,125.11

 

 

Case Analysis 2

For scenario’s A through D please see excel spreadsheet for calculations.

  1. From a financial prospective I would recommend David’s scenario (scenario D). With the assumption of getting an extra two years out of the machine, the Net Present Value and the Internal Rate of Return. The IRR almost doubles to 32.27% and the NPV is $87,447.21
  2. The most aggressive scenario in general is Bob’s (scenario B). Bob is assuming that the savings will generate compounded cash flows. His scenario has the shortest Payback Period. This scenario would require having the inflows re-invested immediately after being realized. Cassidy’s scenario (scenario C) is very aggressive negatively with her scenario, there is no Payback Period and she shows the lowest IRR. I would not recommend this one at all.

 

  1. There is a chance that any one of the calculated scenarios could be the actual scenario that occurs. It is beneficial to weigh all of your options, as to make sound decision. In our case, three of the four scenarios exhibited financial promise thus making The decision to invest in the machine easier.
  2. There are other options to consider when making the decision to purchase the machine. The difference between scenario A and B is the compounding interest on the earnings. Are the earnings going to be placed into an account that will earn interest? The next thing you want to consider is if the machine is going to have a life of 3 or 5 years. The two-year difference has quite a different financial impact. The last piece to research a little more would be the discount rate. At a rate of 15% it is not worth the investment, but the 10% discount rate is worth it.
  3. As the CEO, I would have to have a definitive answer on the life of the machine. If it has a five-year life I would take advantage of the investment. The three-year life makes me a little more cautious because the IRR is not as significant. With the three-year life options, the is a 33.3% chance that the machine could not make a return on the investment at all. In the end, after having a stronger understanding of how the scenario could fall, I would be able to make a final decision. Looking at the number currently, I would probably not make the investment as all the three-year scenarios don’t have a decent IRR.

 

Case Analysis 3

For this case please see excel spreadsheet for calculations.

  1. No, I would not recommend the purchase to management as there is no payback on the investment. The NPV after eight years is -$365,142.56 with a 10% discount rate. If we were calculating with the worst-case scenario of a discount rate of 13% (change cell H118 to 1.13 in the excel calculations) then the NPV is -$409,457.58. The IRR is only 6.72%. The investment with intent to sell for $350,000.00 at the end of the eight years would cause the firm to lose money.
  2. If management would still want to consider the purchase, we would have to find out how many years we would have to hold on to the purchase until a profit could be made. We would also have to see if there are any additional tax savings we could use. Lastly, we could consider if operations could be improved to increase the cash flow.
  3. The first unattractive part of this purchase is that there is no payback. Second, the NPV is -$365,142.56. One more unattractive part is that the IRR is extremely low.
  4. As the CEO I would not approve of the purchase. All the information gathered indicates that the investment is not a wise one. As stated above, the NPV is -$365,142.56, there is no payback and the firm doesn’t make enough money for the purchase to be worthwhile.

 

References

Discounted Payback Period. (2018). Retrieved from Investopedia: https://www.investopedia.com/terms/d/discounted-payback-period.asp

Jassy, D. (2018). What is the formula for calculating internal rate of return (IRR) in Excel? Retrieved from Investopedia: https://www.investopedia.com/ask/answers/022615/what-formula-calculating-internal-rate-return-irr-excel.asp

Net Present Value – NPV. (2018). Retrieved from Investopedia: https://www.investopedia.com/terms/n/npv.asp

Payback Period. (2018). Retrieved from Investopedia: https://www.investopedia.com/terms/p/paybackperiod.asp

Siciliano, G. (2015). Finaance for Nonfinancial Managers. New York: McGraw Hill.