Comprehensive Learning Assessment 1 - CLO 1, CLO 2, CLO 3

Comprehensive Learning Assessment 1 - CLO 1, CLO 2, CLO 3, CLO 4, CLO 5, CLO 7 Please note this assignment consists of two separate parts

Comprehensive Learning Assessment 1 - CLO 1, CLO 2, CLO 3, CLO 4, CLO 5, CLO 7 Please note this assignment consists of two separate parts. The first part gives the cash flows for two mutually exclusive projects and is not related to the second part. The second part is a capital budgeting scenario. Part 1 Calculate the payback period, IRR, MIRR, NPV, and PI for the following two mutually exclusive projects. The required rate of return is 15% and the target payback is 4 years. Explain which project is preferable under each of the four capital budgeting methods mentioned above: see attached picture.

Part 2 Study the following capital budgeting project and then provide explanations for the questions outlined below: You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ), manufacturers of fine zithers (stringed instruments). The market for zithers is growing quickly. The company bought some land three years ago for $2.1 million in anticipation of using it as a toxic waste dump site but has recently hired another company to handle all toxic materials. Based on a recent appraisal, the company believes it could sell the land for $2.3 million on an after-tax basis.

In four years, the land could be sold for $2.4 million after taxes. The company also hired a marketing firm to analyze the zither market, at a cost of $125,000. An excerpt of the marketing report is as follows: The zither industry will have a rapid expansion in the next four years. With the brand name recognition that PUTZ brings to bear, we feel that the company will be able to sell 3,600, 4,300, 5,200, and 3,900 units each year for the next four years, respectively. Again, capitalizing on the name recognition of PUTZ, we feel that a premium price of $750 can be charged for each zither.

Because zithers appear to be a fad, we feel at the end of the four-year period, sales should be discontinued. PUTZ believes that fixed costs for the project will be $415,000 per year, and variable costs are 15% of sales. The equipment necessary for production will cost $3.5 million and will be depreciated according to a three-year MACRS schedule. At the end of the project, the equipment can be scrapped for $350,000. Networking capital of $125,000 will be required immediately.

PUTZ has a 38% tax rate, and the required rate of return on the project is 13%. Now provide detailed explanations for the following: Explain how you determine the initial cash flows. Discuss the notion of sunk costs and identify the sunk cost in this project. Verify how you determine the annual operating cash flows. Explain how you determine the terminal cash flows at the end of the project’s life. Calculate the NPV and IRR of the project and decide if the project is acceptable. If the company that is implementing this project is a publicly traded company, explain and justify how this project will impact the market price of the company’s stock. Provide detailed and precise explanations and definitions. Comment on your findings and provide references for content when necessary. Explain everything in your own words.

Paper For Above instruction

The assignment presents a comprehensive understanding of capital budgeting and investment analysis through two distinct parts: evaluating mutually exclusive projects and analyzing a specific capital investment scenario for PUTZ. Addressing these components requires a detailed analysis of financial metrics, cash flow determination, and their implications on company valuation and market perception.

Part 1: Mutual Projects Analysis - Payback Period, IRR, MIRR, NPV, and PI

The first stage involves calculating and comparing key investment appraisal metrics—payback period, Internal Rate of Return (IRR), Modified Internal Rate of Return (MIRR), Net Present Value (NPV), and Profitability Index (PI)—for two mutually exclusive projects. These projects are independent options; selecting the more favorable one depends on their respective financial indicators relative to the firm's capital criteria.

The payback period measures the time necessary to recover initial investment, emphasizing liquidity and risk. A shorter payback signifies quicker recovery and lower risk. IRR provides the discount rate at which the project's NPV equals zero, indicating potential profitability. MIRR adjusts IRR for reinvestment rate assumptions, giving a more realistic profitability measure. NPV calculates the value added to the firm by discounting cash inflows and outflows at the required rate of return (15%), with positive NPVs indicating wealth creation. PI evaluates the ratio of present value of inflows to outflows, with values above 1.0 indicating acceptable projects.

Comparing these metrics allows a comprehensive evaluation: typically, the project with a shorter payback, higher IRR and MIRR, and greater NPV and PI would be preferable. The decision rules depend on company policy, but generally, all these metrics suggest the preferable project under the firm's investment criteria.

Part 2: Capital Budgeting for PUTZ

Initial Cash Flows and Sunk Costs

The initial cash flows encompass several elements: the immediate outlay for equipment, changes in net working capital, and irrelevant sunk costs. The equipment costs ($3.5 million) are capital investments, and initial net working capital of $125,000 is a necessary incremental expense. The previous land purchase cost of $2.1 million, while an investment in the past, represents a sunk cost that should not influence the current decision; only the appraisal value and potential sale price matter now.

The purchase cost is irrelevant because it occurred three years ago, and current market value ($2.3 million) dictates the feasibility of resale. The marketing study cost ($125,000) is a preliminary expense that, while relevant for overall project analysis, does not affect the initial cash flow calculation directly but helps determine future cash flows.

Annual Operating Cash Flows

Estimating annual operating cash flows involves calculating revenues, deducting operating expenses—fixed costs ($415,000) and variable costs (15% of sales)—and accounting for depreciation, taxes, and non-cash adjustments. Sales volume projections (3,600 to 3,900 units annually) and the unit price ($750) generate annual revenues, which are reduced by variable and fixed costs, resulting in EBIT (Earnings Before Interest and Taxes).

Depreciation is calculated via MACRS over three years, aligning with IRS schedules, impacting taxable income. The tax expense is then deducted to determine net income, which is adjusted for non-cash depreciation to derive operating cash flows. These cash flows are crucial for project evaluation, representing actual funds available for reinvestment or distribution.

Terminal Cash Flows and Salvage Value

At the project's conclusion, terminal cash flows include the after-tax salvage value of the equipment ($350,000), recovery of net working capital ($125,000), and the estimated after-tax sale price of the land ($2.4 million). The after-tax salvage value considers the tax implications of scrapping the equipment, and the land sale incurs capital gains taxes based on the difference between the sale proceeds and its book value.

The recovery of net working capital represents a cash inflow at the end, reflecting its initial outlay. Summing these components provides the total terminal cash flow, vital for calculating the project's overall viability.

Financial Evaluation and Market Impact

Calculating NPV involves discounting all future cash flows, including the terminal inflows, at the company's required rate of return (13%). A positive NPV indicates that the project adds value to the firm, justifying acceptance. IRR provides a threshold rate; if IRR exceeds the required return, the project is acceptable.

Should PUTZ proceed with this project and it is publicly traded, its successful execution and positive valuation could enhance investor confidence, potentially increasing the company's stock price. The perception of growth prospects, driven by the expansion in the zither market, might lead to increased market capitalization, reflecting improved future cash flows as projected.

The market reacts to projected cash flows, risk levels, and strategic fit. Transparency in methodology and confidence in assumptions underpin investor trust, influencing share prices accordingly. The project's positive NPV and strategic alignment are likely to stimulate favorable market responses, reinforcing the company's valuation metrics.

Conclusion

This comprehensive analysis demonstrates the necessity of precise cash flow estimation, understanding sunk costs, and evaluating project profitability through established financial metrics. Proper assessment influences firm value and investor perception, emphasizing the importance of rigorous capital budgeting processes. For PUTZ, the project appears financially viable, with positive implications for firm valuation and investor confidence, provided assumptions hold and market conditions remain favorable.

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