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

WACC., The following is the existing capital structure of Company XYZ Ltd. ...

The following is the existing capital structure of Company XYZ Ltd. Ordinary shares at Shs.10 par 1,000,000 Retained 800,000 12% preference shares Shs.10 par 400,000 16% loan Shs.1

Determine market price of a share, What is the market price of a share of s...

What is the market price of a share of stock for a firm that pays dividends of $1.20 per share, has a P/E of 14, and a dividend payout ratio of 0.4?  market price of a share

Finance calculation, #ques1. Steve and Ed are cousins who were both born on...

#ques1. Steve and Ed are cousins who were both born on the same day, and both turned 25 today. Their grandfather began putting $2,500 per year into a trust fund for Steve on his 20

What are the financial intermediaries, What are the financial intermediarie...

What are the financial intermediaries? Financial Intermediaries: a. Mutual funds b. Pension funds c. Life insurance companies d. Banks

Define the term contractual savings depository institutions, Define the ter...

Define the term contractual savings depository institutions. Contractual savings institutions: Contractual savings institutions obtain funds at periodic intervals onto a

Real Estate Finance - Real options valuation, I need to understand a practi...

I need to understand a practice question for exam, but I only have a partial solution. I need a more detailed solution, so can understand how to arrive at the answer. The problem

Managing financial resources, Two friends, Alan & Tim just graduated from t...

Two friends, Alan & Tim just graduated from the college. They plan to start their own business, of selling health foods for office workers. They have identified a commercial comple

Constant payout ratio, Constant payout ratio 1. This is whereas the fi...

Constant payout ratio 1. This is whereas the firm will pay a fixed dividend rate as like 40 percent of earnings. The DPS would consequently fluctuate as the earnings per share

estimate the price of the bond, Stardusts has 1 debt issue outstanding.  T...

Stardusts has 1 debt issue outstanding.  The debt matures on August 15, 2017, and has a 6.25% coupon.  Coupons are paid semiannually.  The bond is priced to yield 1.61% compound se

Financial Institution Regulations, Why are financial institutions heavily r...

Why are financial institutions heavily regulated, with specific focus on their ability to increase or reduce the money supply?

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