The firm is formed to purchase and operate a vehicle. The purpose of the vehicle is to operate a delivery service for one year. The life of the vehicle is only one year, after which time the vehicle is worthless. The debt will be repaid with interest and the firm will be shut down and capital returned to shareholder at year end. The firm is contemplating the following (base case): Vehicle acquisition cost $ 48,000 Years of useful life (economic life) 1 Tax rate 25% Required rate of return on equity 11% Required return on debt 6% Debt ratio 40% Annual revenues $ 175,000 Operating expenses (EXCLUDING depreciation) $ 115,000
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.
The firm is formed to purchase and operate a vehicle. The purpose of the vehicle is to operate a delivery service for one year. The life of the vehicle is only one year, after which time the vehicle is worthless. The debt will be repaid with interest and the firm will be shut down and capital returned to shareholder at year end.
The firm is contemplating the following (base case):
Vehicle acquisition cost $ 48,000
Years of useful life (economic life) 1
Tax rate 25%
Required rate of
Required return on debt 6%
Debt ratio 40%
Annual revenues $ 175,000
Operating expenses (EXCLUDING
1.Depreciate straight-line over the year of useful life, down to $0 over one year.
- The maximum dividend is paid at year end.
- Ignore any working capital effects.
- Capital charge will be based on the assets at the beginning of each year.
Please writeup your analysis (you may choose to use Excel to develop your analysis, but I will not collect your excel file). Include in the analysis:
- P&L
- OCF analysis
- Economic Profit analysis
- What is the WACC?
- What is the
NPV of this investment? Should investment be considered? - What is the project’s
IRR ? - Report how many dollars are distributed at year end to:
- To debt holder: principal and interest
- To tax authority
- To shareholder
- What is the shareholder's total rate of return?
Immediately after making the investment in this vehicle, find:
- Enterprise Value
- Enterprise value as a multiple of EBITDA
- ROE
- Operating margin
- Times-interest-earned (TIE)
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