Assignment - Part 2

Task 1.

Year Revenue COGS ($) Operating Depreciatio Interest Taxes ($)

($) Costs ($) n ($) Expenses

($)

1 400,000 200,000 50,000 120,000 9,900 42,030

2 650,000 325,000 50,000 120,000 9,900 79,530

3 950,000 475,000 50,000 120,000 9,900 124,530

4 850,000 425,000 50,000 120,000 9,900 109,530

5 450,000 225,000 50,000 120,000 9,900 49,530

Year Net Income Depreciatio Change in Interest Debt Free Cash

($) n ($) Working Expenses Repayment Flow ($)

Capital ($) ($) ($)

0 - - -40,000 - - -640,000

1 98,070 120,000 -25,000 9,900 - 202,970

2 185,570 120,000 -30,000 9,900 - 285,470

3 290,570 120,000 10,000 9,900 - 430,470

4 255,570 120,000 40,000 9,900 - 425,470

5 115,570 120,000 45,000 9,900 -180,000 110,470

WACC = ( E / V * re ) + ( D / V * rd * ( 1 - T ) )

re​= Rf​+ βe​* ( Rm ​− Rf ​)

βe​= βAsset Avg​* 1 + ( ED​* ( 1 − T ) )

D / E ​= ( D / V ) / ( E / V )

βAsset Avg ​= 5βStrideMax ​+ βEcoRun Gear​+ βProFlex Footwear ​+ βTerraTread ​+ βSprintX

Sports​​

= 1.3 + 0.9 + 1.2 + 1.0 + 1.6 / 5​= 6 / 5 ​= 1.2​

D / E ​= ( D / V ) / ( E / V ​= 0.30 / 0.70 ​= 0.4286​

βe​= βAsset Avg​* 1 + ( ED​* ( 1 − T ) ) = 1.2 * ( 1 + ( 0.4286 * 0.7 ) ) = 1.56

re​= Rf​+ βe​* ( Rm ​− Rf ​) = 3.5% + 1.56 * 6% = 12.86%

RD ( Loan interest rate ) = 5.5%

WACC = ( E / V * re ) + ( D / V * rd * ( 1 - T ) ) = ( 0.70 * 12.86% ) + ( 0.30 * 5.5% * 0.7 )

= 10.16%
 Task 3

Discount factors with WACC -> 10.157% :

Year 1: DF1​= ( 1.10157 ) ^1 = 1.10157

Year 2: DF2​= ( 1.10157 ) ^2 =1.21343

Year 3: DF3​= ( 1.10157 ) ^3 = 1.33777

Year 4: DF4​= ( 1.10157 ) ^4 = 1.47575

Year 5: DF5 ​= ( 1.10157 ) ^5 = 1.63052

Present Value of each year ( PV of t ​= Cash Flow of t / Discount Factor of t​)

Year 0: PV of 0 = $640,000​/ 1 = − $640,000

Year 1: PV of 1 = $202,970​/ 1.10157 = $184,184.54

Year 2: PV of 2​= $285,470​/ 1.21343 = $235,362.36

Year 3: PV of 3 ​= $430,470​/ 1.33777 = $321,913.77

Year 4: PV of 4 ​= $425,470 / 1.47575 ​= $288,370.87

Total PV​= $184,184.54 + $235,362.36 + $321,913.77 + $288,370.87 + $67,746.63 =

$1,097,578.17​

Net Present Value (NPV)

NPV = ( ( cash flow / ( 1 + i ) ^t ) ) - initial investment = Total PV − Initial Investment

= $1,097,578.17 − $640,000

= $457,578.17

The NPV is positive so the project is financially viable.

Task 4: Internal Rate of Return - IRR

The step-by-step procedure to calculate IRR goes as follows:

Cash Flows:

Initial Investment Year 0: $640,000

Year 1 Cash Flow: $202,970

Year 2 Cash Flow: $285,470

Year 3 Cash Flow: $430,470

Year 4 Cash Flow: $425,470

Year 5 Cash Flow: $110,470

can be found by solving the equation:

Where: Ct is cash flow in year t,

n is the total number of periods (here 5 years),

IRR is the internal rate of return.

IRR Calculation: Using financial functions—as was performed programmatically—we

iteratively solve for the discount rate which equates the present value of the cash inflows to

the initial investment. The calculated IRR is approximately 34.56%.

What this means is that the rate of return the project is expected to throw out is 34.56%.

Since it is more than the WACC of 10.16%, it is sure to create value.

Task 5

Changes for Scenario Analysis:

Gloomy Scenario: -Discount rate: since the WACC is to be increased by 2%, the new

WACC would be 10.16% + 2% = 12.16%. -Revenues: revenues are gonna decrease by

10%.

Rosy Scenario:

Discount rate: Take WACC and reduce it by 2%, therefore the new WACC = 10.16% - 2% =

8.16%

Revenues: Take revenues and increase them by 10%.

First, for both the base and rosy scenarios, adjust revenues then recalculate an updated

NPV for each.

Gloomy Scenario:

Discount Rate: 12.16%

Revenues: 10% lower

NPV: $874,163.62

This scenario would mean that the NPV is highly negative; therefore, under worsened

market conditions, the project will not be financially viable.

Rosy Scenario:

Discount Rate: 8.16%

Revenues: 10% higher

NPV: $564,535.67

Even in this optimistic case, the NPV remains negative, though better than under the gloomy

situation. However, from this analysis too, the project could still not be commercially viable.

Conclusion: From both the pessimistic and optimistic scenarios, the financial viability of the

project decreases, and the NPV remains negative in both analyses.

Shall we go ahead with Task 6 and the final recommendations?

Task 6

Financial Viability

Base Case: The NPV is $457,578.17, and the IRR is 34.56%, indicating that the project is

viable financially under the original assumptions.

by 10%, results in an NPV turning highly negative at -$874,163.62, showing a high-risk

factor under adverse market conditions.

Rosy Scenario: Even under a more favorable set of circumstances, assuming a lower

discount rate and revenues increased by 10%, the NPV is −$564,535.67, indicating only that

the project may shallowly create value under the most favorable of circumstances.

Risk and Sensitivity This project shows high sensitivity regarding changes in revenues and

the cost of capital. In the "gloomy" case, a minor decline in the market conditions has

disproportionately changed its financials to the very sensitive condition, which could indicate

that the project itself may involve considerable risk if market conditions are unstable or

unpredictable.

Recommendations From the results of the analyses, mixed financial perspectives could be

seen in the project. While the base case provides a positive value, the pessimistic and

optimistic cases have negative NPVs.

Recommendations here are:

Go/No Go Decision:

Revise the Forecasts: Re-consider the revenue forecasts and the market volatility before

proceeding. Spend additional time conducting market research to confirm that the base case

revenues have a high likelihood of being met or exceeded.

Risk Mitigation: The company can dwell on its strategy to mitigate the potential risks that will

improve financial outcomes as follows:

Cost Reduction: The Company must focus on reduction of operating cost and COGS with a

view to increase free cash flows. Operational efficiencies or better supplier terms can lead to

improvement in the bottom line.

probably by offering complementary products or services that enhance sales in varying

market conditions.

Alternative Strategy: If the company is not so confident about the project's financial viability,

it aims to enhance returns. It has to do with:

Strategic Partnership or Outsourcing: Form partnerships or outsource segments of

production processes as a means of cutting down pre-production costs and operation

expenses. That would reduce the initial investment, thereby potentially increasing the NPV.

Delay or Scale Down: To expose less financially, the product can be launched on a smaller

scale. Or it can be delayed until conditions are more favorable.

Final Decision

The project should be accepted if it is believed that major control of costs can be exercised

and revenue forecasts achieved. If the risks seem too great, pushing the project into the

future or working on ways to enhance profitability before undertaking a project could be

advisable.