Investment Assessment Help
  • November 19, 2016
  • David Marks
  • 0

Investment Assessment Help

Investment Assessment HelpEmu Electronics is a producer of electronics goods in Australia which is situated at Box Hill, Victoria. The company has started their business of electronics 50 years ago mainly in the household appliances and radio repairing sector. As per the given case the company earns their major revenue from the selling of the smart phones which is manufactured by the company itself. The smart phone they make are very much exclusive item in the market but recently they are facing a huge challenge due to the rapid change and development in the field of electronics. This pressure situation now forcing them to come up with a new prototype of the smartphone, which must have some key features like facility for Wi-Fi hotspot to compete with the market opponents (Walkowiak, 2003).

The complete monetary necessities for the market research and development for prototype of the new smart phone which the company will manufacture in the upcoming time:

Estimated development cost of the new smart phone = $7, 50,000

Estimated cost for the required research work on the new smart phones = $2, 00,000

Particular of the other costs estimated relating to the manufacturing of the smart phone by the company:

Variable cost per unit of smart phone = $205

Fixed cost assumed per year for the production of the smart phones = $5.1 million

Required primary investments to buy the equipment and machinery for developing the new phones = $34.5 million

Estimation of the selling of the new smart phones in year is given below:

Year Unit Sales
First64000
Second106000
Third87000
Fourth78000
Fifth54000

The assumption of the generation of the revenue for the company as per the estimated sales of the new smart phones per year:

YearUnit SalesRevenue (in $)
First640001,31,20,000
Second1060002,17,30,000
Third870001,78,35,000
Fourth780001,59,90,000
Fifth540001,10,70,000

After launching the new phone the cash flow of the company is being estimated and tabled below:

YearCash Flow (in $)
Primary Investment-4,05,50,000
First1,31,20,000
Second2,17,30,000
Third1,78,35,000
Fourth1,59,90,000
Fifth1,65,70,000

The expected flow of cash of the new product of the company and generated revenue as per the present market value is below:

YearCash FlowPVIF CalculatorPresent Value of the cash flows
Primary Investment-405500001-40550000
First131200000.892911714847.52
Second217300000.797217323155.68
Third178350000.711812694953.24
Fourth159900000.635510161644.97
Fifth165700000.56749401818.14

Issue 1: Payback Period of the Project

The initial time period which is required for the recuperating the invested money in any business from the market is known as the Payback period. It is technique of recovering the initial investment from the market in as much as less time possible.

The payback period for any company is calculated with the help of “Payback Period Calculator” and in this case the payback period is also being calculated in the same process for the Emu Electronics (Romele, 2013).

 As per the above calculations on the given data of the purchase and revenue estimation of the Emu Electronics for their new smart phone business, the payback period for the company is = 2.908.

So it can be studied from the above assumptions that the Emu Electronics needs minimum two years and few months to recover their initial investment in the new project of making smarter phones.

Issue 2: Probability Index of the Project

The investment assessment of any business can be done in a different procedure which is the Probability Index method. In this method the relation between the cost which is used to establish the project and the revenue expected from that project is being identified and evaluated (Mu?ller-Fu?rstenberger, 1997).

The probability index of the project is calculated as a ration among the ‘Current values of cash flows’ to ‘primary investment’ essential for the project from the viewpoint of the fiscal management.

Profitability Index of the Project= (Current Value of Cash Flows / Primary Investment)

Calculation of the Probability index of the Emu Electronics for this project:

Current Value of Cash Flows:

 $(11714847.52+17323155.68+12694953.24+10161644.97+9401818.14)

 = $61296420

Primary Investment =$ 17450000

Profitability Index = (Current Value of Cash Flows / Primary Investment)

                               = ($61296420/$ 40550000)

                               = 1.51

So the probability index for the Emu Electronics for their new project of smart phones, is 1.51which is very much profitable from the company’s perspective.

Issue 3: Internal rate of return of the project

The other most popular techniques of calculating the investment assessment is the ‘internal rate of return’. If the ‘present value of cash flows’ for any business is zero then it is very easy to find out the suitable discount for the business as per the Investment Assessment Helpinternal rate of return. It can also determine the probability of nay firm for the investments should be made for the new project or not (Romele, 2013).

As the above case the given rate of internal rate of return or IRR for the Emu Electronics is given 17% for their new project.

This IRR for the Emu Electronics for their new phone project is very high and it states that this project is very much profitable for the company.

Issue 4: Net Present Value of the Project

The best way to find the investment appraisal for any firm is the ‘Net present value’. In this method the difference among the present value of cash inflow and cash outflow can be easily determined. The net present value in considers the value of money and time in the calculation technique (Hock, 2005).

I this particular case the Net Present Value of the project of manufacturing and selling of new smart phones in Australia is calculated very well considering all the cash inflows and outflows of the Emu Electronics:

YearCash FlowPVIF CalculatorPresent Value of the cash flows
Primary Investment-405500001-40550000
First131200000.892911714847.52
Second217300000.797217323155.68
Third178350000.711812694953.24
Fourth159900000.635510161644.97
Fifth165700000.56749401818.14

So the Net Present Value of the new project by the Emu Electronics is

= $[(13120000+21730000+17835000+15990000+16570000)-40550000]

=$ 20746420

So after the calculation it is sure that the cash inflow is better than the cash outflow and the value is positive. The value amount is very high so the profit margin for the Emu Electronics for their new venture of new smart phone is going to be hugely beneficial for the company.

Issue 5: Analysis and evaluation of sensitivity of net present value with respect to price change

The net present value of any product for the company mainly depends on the price of the product they are launching. The price of the product mainly changes the cash flow of the corresponding business for the company. So the cost flow and the price of the product has a direct relation if the price increases the cash flow will increase automatically and vice-versa.

In the following part the sensitivity of the Present value of the smart phone is discussed:

Sensitivity of NPV with a rise of 10% in the price then the value is $225.5

YearCash Flow(in $)PVIF @12%Present Value of the cash flows
Primary Investment17450000117450000.00
First144320000.892912886333.20
Second239030000.797219055471.85
Third196185000.71181396444.40
Fourth175890000.635511177810.00
Fifth176770000.567410029930.28

For the increase rate 10% of the product the net present value of the product will be = $26563993

Sensitivity of NPV with a decrease of 10% in the price then the value is $184.5

YearCash Flow(in $)PVIF @12%Present Value of the cash flows
Primary Investment-405500001-40550000
First118080000.892910543363.77
Second195570000.797215590841.48
Third160515000.711811425457.56
Fourth143910000.63559145480.41
Fifth154630000.56748773706.27

Now the Net present value for the decrease in the price will be = $14928847

Hence it can be easily understood that the NPV is directly connected with price of the product, increase or decrease in the price of the product will have a huge impact on the NPV of the company in that product.

Issue 6: Analysis of the Sensitivity in the NPV for changes in the selling quantity

Now the number of quantity sold have some great impacts on the net present value of the product. The selling quantity is also directlyrelated with the NPV. Increase or decrease in the quantity sold will change the NPV of the product for the company.

The sensitivity analysis for the NPV of the product on the basis of selling quantity of the product is calculated and described below:

10% rise in the unit sales of the smartphones

YearUnit Sales10% increase in Unit SalesNew Revenue (in $)
1st year640007040014432000
2nd year10600011660023903000
3rd year870009570019618500
4th year780008580017589000
5th year540005940012177000

Sensitivity of NPV calculation with 10% increase in selling quantity

YearCash FlowPVIF @12%Present Value of the cash flows
Primary Investment-405500001-40550000
1st year144320000.892912886332.87
2nd year239030000.797219055470.56
3rd year196185000.711813964447.37
4th year175890000.635511177808.98
5th year176770000.567410029929.88

Now form the above calculation for 10% hike in the selling quantity the NPV of the product for the company will be = $26563995

10 % fall in the unit sales of the product

YearUnit Sales10%decrease in Unit SalesNew Revenue (in $)
1st year640005760011808000
2nd year1060009540019557000
3rd year870007830016051500
4th year780007020014391000
5th year54000486009963000

Sensitivity of NPV calculation with 10% decrease in selling quantity

YearCash FlowPVIF @12%Present Value of the cash flows
Primary Investment-405500001-40550000
1st year118080000.892910543363.27
2nd year195570000.797215590840.45
3rd year160515000.711811425457.85
4th year143910000.63559145481.11
5th year154630000.56748773705.98

Now for the decrease by 10% in the selling quantity will make the NPV of cash flow of the product = $14928850

After comparison between the increase and decrease of the selling quantity it is well understood that the direct relation between the selling quantity and NPV has a huge outcome in cash of the cash inflow of the company.

Issue 7: Endorsement of the Product

From the above discussion and the cash inflow results it is sure that the business will be very much beneficial for the Emu Electronics. Evaluating all the financial investment assessment methods like Profitability Index, Net Present Value, Payback Period and Internal Rate of Return,it is found that the cash inflow of the company after launching the new smart phone will be huge. As the results are all positive the recommendation for the Emu Electronics for their new venture should be to go with this business and endorse their new product.

Issue 8: Analyzing the loss on selling other old Smartphone model

The necessary step to succeed in the business is to come up with something new always as the market demands. So by selling the old products the company may face some loss in there but the huge success of the new product will cover up the loss for them as per the above assumptions and calculations. Without hesitating about the losses the company should come with the new product which is going be a great hit in the market for them as analyzing is being done the different methods. All the investments assessments are carried out the new exclusive product for the company (Grigg, 2010).

Part B

Cost of capital (HCL)

Issue 1: First of all need to find the book value of the equity and debt

FY16 results had been published by the company and from that source the result has been given like;

ParticularsJun-15 ($‘000)Jun-16($’000)
Short term debt
Secured:
Non-trade amount
 – Bank overdraft             32,620.00             36,243.00
 – Commercial bills                9,750.00                9,750.00
 – Syndicated Facility          1,70,000 .00          2,60,000.00
 – short-term borrowings          1,01,808.00          1,02,110 .00
Lease Liabilities                   139 .00                   364 .00
Unsecured:
Derivatives owed                4,104 .00                   325.00
Non trade amount
 – Directors             78,972.00             38,134.00
 – Related party             10,956 .00                5,932.00
 – Unrelated party                      89 .00                   177 .00
Total Short Term(S.T.) Debt          4,08,438 .00          4,53,035.00  
Long term debt
Secured:
Syndicated Facility Agreement           2,90,000 .00          2,00,000.00
Lease liabilities               1,042.00
Total Long Term(L.T.) Debt          2,90,000 .00          2,01,042 .00
Total Debt          6,98,438 .00          6,54,077 .00
EQUITY
contribute equity         3,80,328.00         3,85,296 .00
Reserves         1,13,290 .00         1,55,814 .00
Retained pr       20,43,463 .00       21,25,186.00
Parent entity interests       25,37,081 .00       26,66,296.00  
Non-controlling interest            19,779 .00            22,378 .00
TOTAL EQUITY       25,56,860 .00       26,88,674 .00

It can be identified that the book value of debt in FY16 is equals to $6, 54,077,000.00 approx

And the equity is equals to $26, 88,674,000.00 approx

As on the 23rd Sep value of the current share price of Harvey Norman is equals AUD5.20 (from yahoo finance)

  • The market capitalization: AUD 5,774,159,999
  • Outstanding share number = 1, 112, 555, 911
  • Annual devident is basically:
  • Final dividend + interim dividend = AUD 0.3

Dividend discount model: This is the model where expected dividend of future will be discounted at the rate or cost of the equity as according to the current market value of those stocks. DDM needs three major inputs which are:

  • Growth rate –> Current dividend –> Current price of the share

According to source Bloomberg: Yield on Government debt = 2.034

Cost of equity is basically defined:

Risk free rate + market risk premium * Beta of each stock

As already get the value of the Rf and risk free rate so can easily find the market risk premium. According to the excel sheet calculation as per ASX 200 market returned will be estimated easily.

6% market return value and the risk premium is = 6% – 2% = 4% approximately

Cost of equity = 2% + 4%*0.75 = 5% approx

Issue 2: Interest rate market rate

In $’000Interest RateJun-16Interest
Borrowings5.25%  5,62,110       29,455
Other Loans5.25%     44,243          2,318
Bank Overdraft6.45%     36,243          2,334
Bills payable5.25%        9,750             511
Finance Lease liabilities5.25%        1,406                74
Other financial liabilities5.25%           325                17
Total  6,54,077.00        34,709.00
Book value Pre tax cost of debt5.30%
(Calculated Interest/Debt)

(Yahoo! Finance – Currency Conversion, 2016)

[www.westpaccom source it can be found]

Issue 3: Interest rate

From the annual report cost of debt can be easily identified as according to the given market rate. In according with FY16 (published) pre tax debt will be as per below;

In $Jun-15Interest rateMid ptJun-16Interest rate
Borrowings   5,61,8080.47% – 5.93%3.20%5,62,110     17,988
Loans       90,0173.07% – 4.22%3.65%    44,243        1,613
Overdraft       32,6201.97% – 6.68%4.33%    36,243        1,568
Bills paid         9,7502.08% – 2.72%2.40%      9,750           234
Lease liabilities             1399.50%9.50%      1,406           134
 financial liabilities         4,1045.21% – 5.54%5.38%         325             17
Total   6,98,4386,54,077      21,553.00
Pre tax cost of debt3.30%
(Calculated Interest/Debt)

In order to check the market value and book value will be found market and debt value of the equity. Market value and debt value weights are also differs and since debt value will not being traded in the market can find market and book value weights.

Book ValueWeightsMarket ValueWeights
Debt     6540,77,00019.7%    6540,77,000.0010.3%
Equity  26886,74,00080.4%  57741,59,988.0089.8%
Total  33427,51,000   64282,36,988.00

According to the both book value and market value weights cost of debt can be identified as well like;

  • Weighted avg book value = 19.7% * 5.3% = 1.03%
  • Weighted avg market value = 10.3% * 5.3% = 0.54%
  • According the Annual report the interest value based like as per FY16:
  • Weighted avg book value = 19.7% * 3.3% = 0.66%
  • Weighted avg market value = 10.3% * 3.3% = 0.35%

Issue 4: Weighted avg cost of capital description

From the internet source of www.westpac.com

Book weightsPre tax Post tax Market weightPre tax Post tax
Debt  value19.7%5.31%3.72%10.3%5.30%3.72%
Equity value80.4%5.0%5.00%89.8%5.0%5.0%
Cost of capital value4.8%4.9%

Assume the data from the report of FY16 as;

Book weightsPre tax Post tax Market weightsPre tax Post tax
Debt value19.6%3.30%2.31%10.2%3.30%2.31%
Equity value80.4%5.01%5.01%89.8%5.01%5.01%
Cost of capital value4.5%4.7%

The yahoo source and FY16 annual report value as approximately same as earlier mentioned.

Issue 5: Capital cost

In according to calculate the major value of cost of capital and weighted capital, market value and book value here as a respective company Harvey Norman had being used. Using the pure play approaches it has been clearly identified and according to see the chart of FY16 it has been identified as well (Editorial data, 2002).

Actually here the two companies are different but the market value of both same and also cost of capital of those company mismatches to some level. Peripherals Company as Harvey Norman and Computer Company as HCL is also not exact type of companies, both are different in nature, so market value, book value should be different also.

The cost of the capital should be differing as the value of the cost of the capital based on the past data and it can be reflected in the future also.

References

  • Bams, D., Walkowiak, K. and Wolff, C. (2003). More evidence on the dollar risk premium in the foreign exchange market. London: Centre for Economic Policy Research.
  • Cornell, B. (1999). The equity risk premium. New York: Wiley.
  • Drury, E., Denholm, P. and Margolis, R. (2011). The impact of different economic performance metrics on the perceived value of solar photovoltaics. Golden, CO: National Renewable Energy Laboratory, U.S. Dept. of Energy, Office of Energy Efficiency and Renewable Energy.
  • Editorial data. (2002). Journal of Banking & Finance, 26(1), p.viii.
  • Editorial Data. (2006). Journal of Banking & Finance, 30(1), p.xi.
  • Grigg, N. (2010). Infrastructure finance. Hoboken, N.J.: John Wiley & Sons.
  • Hock, R. (2005). Yahoo! to the max. Medford, N.J.: CyberAge Books/Information Today.
  • Humphreys, B. and Howard, D. (2008). The business of finance Westport, Conn.: Praeger.
  • Life-cycle cost and payback period analysis for commercial unitary air conditioners. (2004). .
  • McMath, H. and Zeller, T. (2011). Estimating Investment Growth Rate And Conditional Internal Rate Of Return. JABR, 9(4), p.39.
  • Meckin, D. (2007). Naked finance. London: Nicholas Brealey Pub.
  • Mu?ller-Fu?rstenberger, G. (1997). The payback period rule. Bern: Universita?t Bern, Abteilung fu?r Angewandte Mikroo?konomie.
  • Perrin, R. (2008). Real world project management. Hoboken, N.J.: John Wiley & Sons.
  • Pratt, S. and Grabowski, R. (2008). Cost of capital. Hoboken, N.J.: John Wiley & Sons.
  • Romele, L. (2013). Estimation of Internal Rate of Return (IRR) to Investments in Education in Latvia.International Journal of Social Science and Humanity, pp.1-4.
  • Yahoo! Finance – Currency Conversion. (2002).

David Marks

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