Deliverable Length: Word Document Of 700-1000 Words With Att

Deliverable Lengthword Document Of 7001000 Words With Attached Exce

Deliverable Length: Word document of 700–1,000 words with attached Excel Spreadsheet showing calculations.

Your final assignment as a financial management intern is to evaluate a capital project using the weighted average cost of capital (WACC) based on market values, and apply capital budgeting techniques such as Net Present Value (NPV) and Internal Rate of Return (IRR). You will recalculate WACC using the current market value of equity, estimate the project's cash flows, calculate depreciation, and determine the project's feasibility. Additionally, you will analyze and compare the advantages and disadvantages of NPV and IRR, and discuss why operating cash flow is used instead of net income in capital budgeting.

Paper For Above instruction

Financial decision-making is an integral aspect of corporate management, particularly when it involves large capital investments. As a financial management intern, your assignment is to evaluate a proposed capital project by calculating the firm’s weighted average cost of capital (WACC) using current market values, determine the project's potential cash flows, and assess its financial viability through capital budgeting techniques such as NPV and IRR. This evaluation will help inform whether the company should undertake the project based on its expected profitability and risk profile.

Recalculation of the Weighted Average Cost of Capital (WACC) Using Market Values

The first step involves revisiting the calculation of WACC with a focus on market values rather than book values, providing a more accurate reflection of the firm's current cost of capital. To do this, you will need to gather current stock prices from a reliable financial website and multiply these by the number of shares outstanding to determine the market value of equity. For simplicity, preferred stock will be omitted, assuming its weight is negligible. The company's total liabilities and calculated market value of equity will then be used to determine the total firm value and respective weights.

Suppose the company has a stock price of $50 per share, with 10 million shares outstanding. The market value of equity would be $500 million. If the company's total liabilities amount to $200 million, the total firm value becomes $700 million (equity + liabilities). The weights for each component are then calculated: weight of equity = $500 million / $700 million ≈ 0.714, weight of debt = $200 million / $700 million ≈ 0.286.

The cost of equity can be estimated using the Capital Asset Pricing Model (CAPM), based on the current risk-free rate, beta, and market risk premium. The after-tax cost of debt is derived from current yield on outstanding debt. These components are incorporated into the WACC formula:

WACC = (E/V) Re + (D/V) Rd * (1 - Tc)

where E = market value of equity, D = market value of debt, V = E + D, Re = cost of equity, Rd = cost of debt, and Tc = corporate tax rate.

Estimating the Project’s Cash Flows

The project requires an initial outlay of $12 million, with a salvage value of $2 million after five years. Straight-line depreciation over this period results in annual depreciation expenses calculated as:

Depreciable amount = Initial investment - Salvage value = $12 million - $2 million = $10 million

Depreciation per year = $10 million / 5 = $2 million.

Assuming an average tax rate of 25%, we then project yearly revenues and expenses increases: revenue grows by $10 million annually, and expenses increase by $6.5 million annually, excluding depreciation.

Calculating yearly operating income, taxable income, taxes, net income, and operating cash flows involves adjusting for depreciation and taxes. These cash flows form the basis for capital budgeting analysis.

Calculating the Net Present Value (NPV) and Internal Rate of Return (IRR)

The NPV is calculated by discounting the project's cash flows at the market-value-derived WACC. The IRR is the discount rate that equates the present value of cash inflows with the initial investment. Doing so encompasses deriving annual after-tax cash flows over five years, then applying straightforward financial formulas or spreadsheet functions to compute NPV and IRR.

Analysis and Interpretation of Results

If the NPV is positive and the IRR exceeds the required rate of return (e.g., the WACC), the project appears financially feasible. Conversely, a negative NPV or an IRR below the threshold suggests rejection. This consistency stems from both methods estimating the project's value in terms of the firm's cost of capital, although they approach the evaluation differently.

Applying a hypothetical cost of capital of 20% offers perspective on sensitivity; if the project's NPV remains positive at this higher rate, it indicates robust profitability. If not, the investment's viability diminishes, emphasizing the importance of accurate discount rate estimation.

Advantages and Disadvantages of NPV and IRR

NPV's advantages include its direct measure of added value to the firm and its consistent decision rule regardless of project scale or timing. Its main disadvantage is the reliance on an accurate discount rate, which can be challenging to determine precisely. IRR’s advantages are intuitiveness and ease of understanding, as it expresses return as a percentage, facilitating comparisons. However, IRR can produce misleading results when projects have non-conventional cash flows or multiple IRRs, making NPV generally more reliable in complex scenarios.

In real-world applications, NPV is preferred for its accuracy in value addition, especially when dealing with divergent project sizes or complex cash flow patterns. IRR may be more useful for quick assessments or when capital constraints limit options.

Regarding the use of operating cash flow instead of net income, operating cash flow reflects actual cash generated by the project after accounting for expenses, excluding non-cash items and financing activities. This makes it a more accurate measure for assessing the project's liquidity and true profitability over time (Ross, Westerfield, & Jaffe, 2019).

Conclusion

In conclusion, evaluating a capital project requires careful calculation of WACC based on current market values, precise estimation of cash flows, and appropriate application of capital budgeting techniques like NPV and IRR. Both methods provide valuable insights, but NPV’s superiority in value-based decision-making makes it more reliable in most circumstances. Ultimately, the decision to approve or reject should consider the project's profitability relative to the firm’s cost of capital, market conditions, and strategic alignment, supported by comprehensive analysis and credible data.

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