FORT GREEN
WORLD
MAHAM IBRAHIM L1F11BBAM2024 AHSAN EJAZ L1F11BBAM2164
SUBMITTED TO : PROF. EESHA TARIQ SECTION : B SUBJECT : FINANCIAL ANALYSIS
QUESTION 1
(A)Calculation of NPV of modernizing the existing paper mill: If actual cash flows are used
Investment required for the modernization = $154,700,000 Required rate of return = 12%
Yearly cash flow after tax deduction = $40,634,680 (for 20 years)
Net present value = C0 + present value of all future cash flows of 20 years NPV = 303,518,451.5 - 154,700,000
NPV = $148,818,451.5
(B) Calculation of NPV for building a new paper mill Investment required for the modernization = $618,800,000 Required rate of return = 12%
Yearly cash flow after tax deduction = $107,728,000 ( for 20 years) NPV = 804,668,222.8 - 618,800,000
NPV = $185,868,222.8
With Incremental Cash Flows
(A)Calculation of NPV of modernizing the existing paper mill: Investment required for the modernization = $154,700,000
Required rate of return = 12%
Yearly cash flow after tax deduction = $40,634,680 (for 20 years) Incremental cash flow= $ 40,634,680- $ 11,422,320 = $29,212,360 Net present value = C0 + present value of all future cash flows of 20 years
Casio calculator a) Cash button b) I% = 12% c) Cash= D.editor x X 1 -154700000 2 29,212,360 3 29,212,360 4 29,212,360 5 29,212,360 6 29,212,360 7 29,212,360 8 29,212,360 9 29,212,360 10 29,212,360 11 29,212,360 12 29,212,360 13 29,212,360 14 29,212,360 15 29,212,360 16 29,212,360 17 29,212,360 18 29,212,360 19 29,212,360 20 29,212,360 21 29,212,360
d) NPV = solve
e) NPV = $ 63,500,076.15
(B) Calculation of NPV for building a new paper mill Investment required for the modernization = $618,800,000 Required rate of return = 12%
Yearly cash flow after tax deduction = $107,728,000 ( for 20 years) Incremental cash flow =$107,728,000 - $ 11,422,320 = $ 96,305,680 Net present value = C0 + present value of all future cashflows of 20 years
Casio calculator a) Cash button b) I% = 12% c) Cash= D.editor x X 1 -618,800,000 2 96,305,680 3 96,305,680 4 96,305,680 5 96,305,680 6 96,305,680 7 96,305,680 8 96,305,680 9 96,305,680 10 96,305,680 11 96,305,680 12 96,305,680
13 96,305,680 14 96,305,680 15 96,305,680 16 96,305,680 17 96,305,680 18 96,305,680 19 96,305,680 20 96,305,680 21 96,305,680 d) NPV = solve e) NPV = $ 100,549,850
This shows that NPV of new paper mill is higher than that of modernization of the existing facility. Thus, using NPV rule demonstrates that new facility is better for the firm.
QUESTION 2:
With Incremental Cash flows
(A)Calculation of IRR of each investment IRR of Modernization of existing mill :
Using the Casio calculator where the cash flows and the initial investment was entered we move on to the
IRR = solve IRR = 18.219%
IRR of new paper mill:
Using the Casio calculator where the cash flows and the initial investment was entered we move on to the
IRR = solve IRR = 14.531%
According to IRR rule the firm should invest in the modernization of the existing paper mill as it has a higher IRR .
(B) Calculation of the payback period of each investment Payback period of Modernization of existing mill : Initial investment / annual cash flows
= $154,700,000/$40,634,680 = 3.807 years
Payback period of new paper mill: Initial investment / annual cash flows = $618,800,000/$107,728,000
= 5.744 years
According to payback rule the investment made in the modernization of existing paper mill will be recovered earlier then the investment in the new paper mill.
IRR With Actual Cash flows
IRR of Modernization of existing mill : Investment= $154,700,000
Cash flows= $40,634,680 IRR = SOLVE
IRR=26.01%
IRR of New Paper Mill Investment= $618,800,000 Cash flows= $107,728,000 IRR= SOLVE
QUESTION 3:
(A)NPV and IRR methods give the same accept / reject signals:
No, NPV and IRR methods do not give the same accept/ reject signals. NPV accepts the investment in building a new paper mill while IRR method accepts the investment in the modernization of the existing paper mill.
(B) NPV and IRR methods can give divergent signals when evaluating mutually exclusive alternatives:
In mutually exclusive projects, all projects serve the same purpose and therefore such projects cannot be undertaken simultaneously. In case of mutually exclusive projects only one project can be accepted and the others are to be rejected. In case of such projects the cash flows of one project can actually be adversely affected by the acceptance of the other project.
The reason that NPV and IRR methods are giving different decisions for the projects, building of new paper mill and modernization of existing paper mill are:
The investment scale is different for both the projects. Building a new paper mill requires higher investment as compared to the other project.
The cash flows are also different of both the projects. The cash flow of building a new paper mill is $67,093,320 more than the cash flow of the modernization of existing paper mill. Thus, the magnitude of cash flows is also the reason of divergent signals.
QUESTION 4:
If the life of modernized paper mill becomes 15 years the payback period as calculated in Question 2 part b would not change and would remain 3.807 years but the NPV if calculated would change.
Investment required for the modernization = $154,700,000 Required rate of return = 12%
Yearly cash flow after tax deduction = $40,634,680 (for 15 years)
Net present value = C0 + present value of all future cash flows of 15 years
Casio calculator a) Cash button b) I% = 12% c) Cash= D.editor x X 1 -154700000 2 40634680 3 40634680 4 40634680 5 40634680 6 40634680 7 40634680 8 40634680 9 40634680 10 40634680 11 40634680 12 40634680 13 40634680
14 40634680 15 40634680 16 40634680 d) NPV = solve e) NPV = $122,057,300 f) IRR = solve g) IRR = 25.384%
If Incremental Cash Flows are Used:
Casio calculator a) Cash button b) I% = 12% c) Cash= D.editor x x 1 -154700000 2 29,212,360 3 29,212,360 4 29,212,360 5 29,212,360 6 29,212,360 7 29,212,360 8 29,212,360 9 29,212,360 10 29,212,360 11 29,212,360 12 29,212,360 13 29,212,360 14 29,212,36015 29,212,360 16 29,212,360 d) NPV= solve e) NPV=$ 44,261,425.38 f) IRR= solve g) IRR = 17.118%
The NPV decreases with the decrease in number of years but still remain positive. Similarly there is a decrease in IRR with the change in number of years. The IRR has decreased round about 1.1% as compared to previous IRR calculation with 20 years cash flows.
Thus, it shows the effect of latter cash flows on IRR and NPV is less and early cash flows have greater effect on IRR and NPV. Therefore it’s a better option to choose modernization of existing paper mill as it has a lower payback, positive NPV and higher IRR and the employees only have to cover 15 miles to reach it.
According to the statement the yearly cash flows if multiplied by 5 give a large cash flow that is actually affecting the NPV but in reality the effect is very little and 5 years can also be omitted.
QUESTION 5:
Based on the calculations, modernization the existing facility would be better option because of its early payback, higher IRR and positive NPV (although less than that of new facility). Based on the information in the case, modernization the existing facility would be again better because new facility location is 15 miles away from the existing facility which would increase the employees' expense and this would be unfair with employees and it may decrease their loyalty for company. So, we recommend to modernize the existing facility.
QUESTION 6:
(A) Casio calculator a) Cash button b) I% = 12% c) Cash= D.editor x X 1 -464,100,000 2 67093320 3 67093320 4 67093320 5 67093320 6 67093320 7 67093320 8 67093320 9 67093320 10 67093320 11 67093320 12 67093320 13 67093320 14 67093320 15 67093320 16 67093320 17 67093320 18 67093320 19 67093320 20 6709332021 67093320
d) IRR = solve e) IRR = 13.258%
13.258% is the crossover rate of both the projects where there NPV = $126,379,470. If we compare this rate to the required return 12% we will accept the project because the rate at which the NPV of both the projects becomes equal is more than the required return.
Further if the cash flows have been overestimated this may be causing the result of IRR to be 13.248% that is only 1.25% more than required return may be the actual cash flows are lower which may lower the IRR to 12% or even lower than that that can actually make the project unacceptable.
(B)
If we explain the decision rule for IRR in case of mutually exclusive alternatives, we accept a project which has IRR greater than its cost of capital, and If both the projects have IRR greater than their cost of capital than we select the project having the highest IRR.
In mutually exclusive alternatives normally IRR and NPV give divergent signals which means if IRR accepts a project, NPV rejects that project. Thus in this case NPV should be used as a primary rule.
On the other hand if these projects would have been independent projects, IRR and NPV would have given same answers. Normally in case of independent projects if NPV accepts the project than IRR also gives the same decision. And In such projects we can accept all the projects if there are no constraints.
QUESTION 7:
Data required for calculating the yearly cash flow Modernization of existing paper mill ($)
Building new paper mill ($)
Initial Cost 154,700,000 618,800,000
Price per ton 455 455
Working days in a year 360 days 360 days
Tonnage per day 1200 2200
Variable cost per ton 282.1 227.50
Fixed operating cost per year
19,860,000 52,200,000
SL value 20 years 20 years
Depreciation per year 7,735,000 30,940,000
Tax rate 40% 40%
Income statement for calculation of the operating cash flow: Modernizing existing
facility
Building new building Sales
(Price per ton x number of tons x no. of days in a year)
455 x1200 x360= $196,560,000
455 x2200 x360= $360,360,000
Less: Fixed cost per year (includes depreciation)
($19,860,000) ($52,200,000)
Less: variable cost per year 282.1 x 1200 x 360= ($121,867,200) 227.5 x 2200 x 360= ($180,180,000) EBT $54,832,800 $ 127,980,000 Less: 40% tax ($ 21,933,120) ($ 51,192,000) Net income $ 32,899,680 $ 76,788,000 Add Depreciation $ 7,735,000 $ 30,940,000
QUESTION 8:
(A) Calculating operating cash flows 1st 5year cash flows would be:
Modernization the old mill Building a new mill
Sales $196,560,000 $360,360,000
Less: F.C.(dep not included) (12,125,000) (21,260,000)
Less: VC (121,867,200) (180,180,000) Dep (SL5 years)=initial investment/5 (30,940,000) (123,760,000) EBT 31,627,800 35,160,000 Less: tax (12,651,120) (14,064,000)
Free Cash Flow 18976680 21096000
Add: Dep 30940000 123760000
Net Cash Flow 49,916,680 144,856,000
Now, the net cash flows for rest of 15 years would be:
Modernization the old mill Building a new mill
Sales 196560000 360360000
Less: F.C.(dep not included) (12,125,000) (21,260,000)
Less: VC (121,867,200) (180,180,000)
EBT 62567800 158920000
Less: tax (25,027,120) (63,568,000)
Net Cash Flow 37,540,680 95,352,000
Required rate of return and Initial investment is given. Using the financial calculator, NPV would be
NPV 170,320,703.2 271,877,229.6
IRR 29.98% 19.74%
(B)
Q8 (b) Modernization the old mill Building a new mill
NPV (dep for 20 years) $ 148,818,451.5 $ 185,868,222.8
NPV (dep for 5 years) $ 170,320,703.2 $ 271,877,229.6
NPV change $ 21,502,251.7 $ 86,009,006.8
NPV change % 14.45% 46.32%
If Incremental Cash flows are used with Depreciation being Charged for First 5 Years for Modernized Mill
Incremental cash flow for first 5 years of modernized mill = $ 49,916,680 - $11,422,320 = $38,494,360
Incremental cash flow for last 15 years of modernized mill =$ 37,540,680 -$ 11,422,320 = $ 26,118,360 Casio calculator a) Cash button b) I% = 12% c) Cash= D.editor x X 1 -154700000 2 38,494,360 3 38,494,360 4 38,494,360 5 38,494,360 6 38,494,360 7 26,118,360 8 26,118,360
9 26,118,360 10 26,118,360 11 26,118,360 12 26,118,360 13 26,118,360 14 26,118,360 15 26,118,360 16 26,118,360 17 26,118,360 18 26,118,360 19 26,118,360 20 26,118,360 21 26,118,360 d) NPV = solve e) NPV = $ 85,002,327.86 f) IRR= solve g) IRR = 21.5224%
Incremental cash flow for new paper mill Incremental cash flow for first five years = $ 144,856,000 - $ 11,422,320
= $ 133,433,680
Incremental cash flow for last 15 years = $ 95,352,000- $11,422,320
= $ 83,929,680 Casio calculator
a) Cash button b) I% = 12% c) Cash= D.editor x X 1 -618,800,000 2 133,433,680 3 133,433,680 4 133,433,680 5 133,433,680 6 133,433,680 7 83,929,680 8 83,929,680 9 83,929,680 10 83,929,680 11 83,929,680 12 83,929,680 13 83,929,680 14 83,929,680 15 83,929,680 16 83,929,680 17 83,929,680 18 83,929,680 19 83,929,680 20 83,929,680 21 83,929,680 d) NPV = solve e) NPV = $ 186,558,850 f) IRR= solve
g) IRR = 17.4369%
Modernized mill New mill
NPV of project with 20 year depreciation
$ 63,500,076.15 $ 100,549,850
NPV of project with 5 year depreciation
$ 85,002,327.86 $ 186,558,850
IRR of project with 20 year depreciation
18.219% 14.531%
IRR of project with 5 year depreciation
21.5224% 17.4369%
Change in NPV $ 21,502,251.71 $ 86,009,000
Change in IRR 3.3034% 2.9059%
NPV change in % 33.86% 85.54%
By using incremental cash flows also we get to know that the percentage change in NPV of new mill project is higher.
The NPV change would be higher in building a new mill, possible reasons would be the magnitude of early and latter cash flows. Latter cash flows experience greater impact of discount rate rather early cash flows. 5 year depreciation makes early cash flows higher.
QUESTION 9:
For calculating the cash flow where the annual production is minimum which makes the project unacceptable we calculate the payment through annuity formula:
PV= C x ((1-(1+r)-n)/r) R= 12%
n= 20
Calculation of Cash Flow Modernization of existing mill Building New Mill
Cash Flows 154,700,000/((1-(1+0.12)-20)/0.12)
=$ 20711047.27
618,800,000/((1-(1+0.12)-20)/0.12)
Minimum annual production
Modernization of existing mill Building New Mill Operating cash flow $ 20,711,047.27 $ 82,844,189.09
Less: depreciation ($7,735,000) ($30,940,000)
Net Income 12,976,047.27 51,904,189.09
EBT $ 21,626,745.45 $86,506,981.82
Add Fixed Cost $ 19,860,000 $ 52, 200,000
Gross profit $ 41,486,745.45 $ 138,706,981.8
Tonnage per year 239,946.47455 609,701.019
Add Variable Cost = tonnage per year x variable cost per ton
$ 67,688,900.47 $ 138,706,981.8
Sales $ 109,175,645.9 $ 277,413,963.6
Modernization of existing mill: Net income = (EBT – EBT x40%) =EBT (1-(1 x 40%))
EBT= Net Income/ (1-(1 x.4)) = 12,976,047.27/ (1-(1 x .4)) = $ 21626745.45
Building new paper mill
Net income = (EBT – EBT x40%) =EBT (1-(1 x 40%))
EBT= Net Income/ (1-(1 x.4)) = 51,904,189.09/ (1-(1 x .4)) =$86506981.82
Tonnage per Year:
Gross profit = Tonnage per year (price per ton (sales) – variable cost per ton)
Modernized existing mill tonnage per year= $ 41486745.45/ (455- 282.1) = $ 239946.4746 New mill tonnage per year =$ 138706981.8/ (455- 227.5) = $ 609701.019
QUESTION 10:
(A)No, it is not appropriate to judge different proposals on same discount rate because each proposal has its own cost and cost of capital which is according to its risk. So, in order to evaluate the proposals, we should compare proposal's own cost of capital with its IRR. If IRR is greater than that of its cost of capital proposal should be accepted otherwise rejected.
(B)
Yes, it is possible that my decision would be change if both projects have different cost of capital. Change in cost of capital can also change the decision we made on the basis of IRR in question 5 of selecting the project of modernization of existing mill. If both projects would have higher IRR than their discount rate than I would select project with higher NPV.