Analysis on capital budgeting npv or eaa, Finance Basics

Assignment Help:

As the Chief Financial Officer for the wholly Australian owned, Australian Stock Exchange listed company, Toy Show Ltd., an importer and manufacturer of a range of quality children's products sold throughout Australia, you have recently undertaken an evaluation of 2 mutually-exclusive machines that could assist the company in meeting its demand for the production of dolls houses. One of the machines is sourced from Germany and has a four-year expected life and the other is from Australia and has a six-year expected life. Each machine could comfortably cope with current and anticipated future production volumes for its premium dolls house lines.

You are now in the process of bringing together the capital budgeting information collected and preparing your final recommendations to be presented to the Board of Directors of the company at a special meeting that has been called to discuss your results and recommendations. Having had experience in making such presentations in the past to the current Board, you are aware that none have any extensive finance skills. As a result, it is important to provide any discussion in a manner that incorporates appropriate technical terms where relevant, but should where possible, use language that is clear and not presume any significant finance background.

The capital budgeting details prepared to date regarding the alternative machines are shown in the table below: Purchase price

Before-tax Present value of product sales

After-tax Present value of product sales

Before-tax Present value of operational costs

After-tax Present value of operational costs

German machine

$3.1 million

$27 million

$21.5 million

$20 million

$16 million

Australian machine

$4.2 million

$38 million

$29.9 million

$29 million

$23 million











In addition, you have collected the following current information about the company: Current share price:

$12

Number of shares on issue:

2,500,000

Current weighted average cost of capital:

14.5%

a) i) Why should your analysis of this capital budgeting proposal be undertaken on a before-tax basis?

ii) In the context of the question provide some thoughts as to why the machines subject to evaluation are stated to be "mutually-exclusive.

b) i) Calculate the appropriate (before-tax) net present value (NPV) of both the German and Australian sourced machines.

ii) Briefly explain why the NPV calculated above is not sufficient to make a selection between the 2 mutually-exclusive machines for capital budgeting purposes.

c) i) Calculate the appropriate value of both the German and Australian sourced machines based on the Equivalent Annual Annuity (EAA) approach. Include a brief explanation of the processes used for each calculation and an interpretation understandable to the Board as to what each calculation represents.

ii) Make a capital budgeting selection of either the German or Australian sourced machine based on your calculations in part c) i) of this question. Briefly justify your response.

d) i) Having made your capital budgeting selection, why would this financial decision be expected to impact on the company's share price? Briefly justify your response.

Note: No calculations are required for this part of the question - only a statement as to the expected direction of the share-price movement is required with a justification as support for your response.

ii) Following your discussion in part d) i) of this question, when would it be expected that a movement in the company's current share price would occur? Briefly justify your response.

iii) Given your statements in parts d) i) and ii) of this question, showing all calculations, what would be the amount of the expected change in the company's current share price and what is the anticipated new share price after this change? Briefly justify your response.

iv) In your opinion, why in practice is it likely that the actual fluctuation in the share price will be different from that calculated in part d) iii) of this question? Provide an explanation that could be used to present to the Board of Directors of the company.


Related Discussions:- Analysis on capital budgeting npv or eaa

Different evaluation horizons and mbo, Different Evaluation Horizons and MB...

Different Evaluation Horizons and MBO Different Evaluation Horizons Managers might undertake projects that are profitable in short-run. Shareholders on the other hand evalu

Tom and Martha Holt Case Study., Which of the following retirement plan alt...

Which of the following retirement plan alternatives would allow Tom the greatest deductible contribution while providing him with only a small cash flow commitment each year based

Intro to finance, discuss the flow of fund in an open economy

discuss the flow of fund in an open economy

Similarities between equity finance and preference, Similarities between Eq...

Similarities between Equity Finance and Preference Similarities among Equity Finance and Preference are as follows: a) Both may be permanent whether preference share capita

Solutions - relationship between auditors and shareholders, Solutions to th...

Solutions to the conflict - Relationship between Auditors and Shareholders 1. Firing The auditors may be detached from office at the AGM via the shareholders. 2. Lega

Mortgages - financial institutions, Mortgages - Financial Institutions ...

Mortgages - Financial Institutions An arrangement of the property being purchased provides the security for funding. Other assets may be employed like security for funding o

Drawback of stock repurchases, Drawback of Stock Repurchases 1. High ...

Drawback of Stock Repurchases 1. High price A company may find it not easy to repurchase shares at their recent value and price paid may be higher to the detriment of rem

How capital budgeting decisions affect a company’s value, Give an example o...

Give an example of how capital budgeting decisions affect a company's value, strategy or operations. Companies always tend to look for capex projects which will add value to

Different risk-profile - shareholders and management, Different Risk-profil...

Different Risk-profile - Shareholders and Management Shareholders will generally prefer high-risk-high return investments while they are diversified that is they have many inv

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd