Reference no: EM132397592

Financial Management

Case : Capital budgeting analysis

This case is for teams of two to four students. You may not do it alone without prior approval. Teams may not have more than four students. As much as possible, I will rely on you to select those you would like to work with. On Monday and Wednesday next week, we will take some time during class to identify teams that would like an additional member or students that are still looking for a team to work with.

Part 1 - Forecast project cash flows and horizon value

1. Select a proposed capital budgeting project to evaluate.

The project selected can involve a new business or an expansion of an existing business (including, e.g., a new location, new product, or increased production). Almost any type of business could be examined, with the possible exception of businesses that are principally financial in nature (banks, securities firms, insurers, etc.)See Attachment 1for list of possible projects. You are not limited to projects that appear on this list. If you have questions abouta particular project, check with me.

2. Forecast the initial investment and the monthly expected cash flows for your team's capital budgeting projectfor the first three years of operation assuming the project is funded entirely with equity.See Attachment 2 for a list of possible line items to include in the initial investment and operating periods.

3. Estimate the horizon value as of month 36 using at least two different methods. Articulate why the methods selected should provide a better estimate of horizon value than those not used. Select one of the two horizon values or use a weighted average of them as the horizon value for your project.

Part 2 - Valuethe equity funded project

4. Determine an appropriate discount rate using the capital asset pricing model, with beta estimated from comparable publicly traded firms. Note that if the comparable firms are partly funded by debt, the equity betas for those firms must be unlevered to obtain the asset beta (i.e., the 100% equity beta).

5a. Calculate the net present value of the project.

b. Calculate the project's internal rate of return.

c. Determine the project's payback period.

Part 3 - Select the organizational form

6. Select an organizational form that is appropriate for the project. Discuss briefly the rationale for that organizational form, including the effect the form selected has on the value of the project.

Part 4 - Recommend a capital structure and type of funding

7. Select a capital structure for the project. Indicate the recommended funding mix of debt and equity for initial investment in the project and explain why the recommended capital structure is appropriate. With respect to debt selected, specify the recommended type of debt (interest only, amortized) and the maturity for the debt. Explain the rationale for the recommended type and maturity.

8. Determine the net present value of the leveraged projectwith the selected capital structure. Calculate the NPV using at least two of the following methods: weighted average cost of capital; adjusted present value; and/or flow to equity.

Part 5 - Additional project analysis

Conduct additional analysis of the project as follows:

9.Calculate three break-even points (other than the payback period and internal rate of return) that are useful for understanding the project. Discuss briefly each of these break-even points and the insight it provides.

10. Analyze an additional scenario for the project (i.e., in addition to the "expected" scenario already valued.)

11. Conduct a sensitivity analysis for the project.Determine the sensitivity of project NPV to changes in at least six assumptions, one of which must be from the initial investment, four must affect operating cash flows, and one must affect the discount rate. Discussyour findings about the relationship between the assumptions tested andproject value.

12. Explain what variables (at least five)would be included if a conduct a Monte Carlo simulationwere conducted for this project. For each variable, describe the characteristics of each random variable (e.g., if the variable is uniformly distributed, what should the high and low values be; if it is normally distributed, what should the mean and variance be or how could these be determined; should the values be limited to integers; and etc.)