Giangelo Corporation would like to venture in manufacturing a specialized tool that is required by a semi-conductor company. In order to accomplish this, it is considering two options that both require raising large amount of funds. First option (Project X) is the construction of a factory building and acquisition of machineries for an estimated cost of P30 million. The other alternative (Project Y) is the acquisition of an existing company that manufactures the same tool at a price of P50 million. In order to fund the project, the Company will have to apply for a loan from a bank and issue shares of stocks. The management contemplated a more leveraged approach by availing the 70% of the financial requirements through loan borrowing and the rest from the issuance of shares. The interest on bank loan is at 11% per annum while the issuance of shares will require return to stockholders at 8% per annum. The applicable income tax rate is 25%. Both of the projects will have estimated life of 10 years with no salvage value. The following are the information on the related revenues and expenses of the two projects. Project X Project Y Annual revenue P 20,000,000 P30,000,000 Annual cash cost and expenses excluding interest P 12,700,000 P18,000,000 What is your recommendation to the management? Provide support.
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Giangelo Corporation would like to venture in manufacturing a specialized tool that is required
by a semi-conductor company. In order to accomplish this, it is considering two options that
both require raising large amount of funds. First option (Project X) is the construction of a
factory building and acquisition of machineries for an estimated cost of P30 million. The other
alternative (Project Y) is the acquisition of an existing company that manufactures the same
tool at a price of P50 million.
In order to fund the project, the Company will have to apply for a loan from a bank and issue
shares of stocks. The management contemplated a more leveraged approach by availing the
70% of the financial requirements through loan borrowing and the rest from the issuance of
shares. The interest on bank loan is at 11% per annum while the issuance of shares will require
return to stockholders at 8% per annum. The applicable income tax rate is 25%.
Both of the projects will have estimated life of 10 years with no salvage value. The following
are the information on the related revenues and expenses of the two projects.
Project X
Project Y
Annual revenue
P 20,000,000
P30,000,000
Annual cash cost and expenses
excluding interest
P 12,700,000
P18,000,000
What is your recommendation to the management? Provide support.
Step by step
Solved in 6 steps with 9 images
