Easy Finance Work Due In 4 Hours

Easy Finance Work Due In 4 Hourschocolat Cordon Rougecorporate Finance

You are part of Marcel Arnaud’s team to analyze the 7 different projects under consideration. The table in the case describes the expected cash flows of the different projects. All the costs and benefits of the projects have been taken into consideration except for two potential costs: 1. John Hsu, the manager sponsoring the project to build a factory in the U.S., did not include the loss in output of the French plant in Years 4-10. He claims that those cash flows are not part of his proposed project and as such should not be included. 2. Bertrand Godard, who is proposing to expand capacity in Brittany, has not included the cost of the land because he claims that the firm already owns it. However, you should note that the cash flows of the project include the sale of the land in year 10. Before conducting your analysis, think about whether these decisions are correct and, if not, adjust the cash flows accordingly. Clarifications: • The case gives you the WACC of each project. This is just the discount rate. As the case indicates, CCR has only €75M in its bank account to pay for the projects’ investment costs.

Paper For Above instruction

The task involves analyzing seven prospective projects by calculating their net present values (NPV) and internal rates of return (IRR), and then recommending which projects to undertake given the firm’s financial constraints. Critical to this analysis are considerations surrounding the accuracy of reported cash flows, specifically the exclusion of certain costs and benefits by project sponsors. Adjustments are necessary to correctly assess each project's viability, particularly regarding the operational losses of the French plant and the land sale associated with the Brittany project.

Introduction

In corporate finance, investment decisions hinge on accurately estimating the value a project adds to the firm, primarily via metrics like NPV and IRR. These metrics reflect the discounted value of expected cash flows, which should comprehensively account for all relevant costs and benefits, including opportunity costs and salvage values. This analysis scrutinizes seven projects under consideration by CCR, evaluating their financial merits through these metrics, with particular attention to potential oversights in cash flow estimates. Correcting these cash flows is essential to avoid over- or underestimating project profitability and to align with sound financial principles.

Assessment of Cash Flows and Corrections

The first key issue involves the exclusion of the operational losses of the French plant spanning Years 4-10 in Hsu’s US factory project. While Hsu claims these are not directly linked to the US project, from a holistic financial perspective, the opportunity cost of lost output in France represents a relevant cash flow—an implicit cost of diverting resources. Its exclusion could lead to an inflated project valuation. Therefore, these foregone revenues should be incorporated into the project's cash flows as an opportunity cost.

The second issue concerns the Brittany expansion project. Godard’s proposal omits the land cost, asserting that the land is already owned. However, the project forecasts include a revenue from land sale in Year 10. Since the firm already owns the land, its initial purchase cost should be considered a sunk cost and excluded from the project’s incremental cash flows. Nonetheless, the sale proceeds are relevant as they are part of the project’s direct cash inflows, provided that the sale is a cash benefit already realized or expected to be realized within the project horizon. If the value of the land sale is indeed included in the cash flows, no adjustment is necessary other than recognizing that the land's purchase cost is a sunk investment already accounted for elsewhere.

Accurate calculation of NPVs and IRRs necessitates these adjustments, ensuring that all variable costs and benefits directly attributable to the project are incorporated.

Methodology

The evaluation proceeds by calculating the NPVs for each project using their given Weighted Average Cost of Capital (WACC) as the discount rate. The IRR is derived by finding the discount rate that sets the NPV to zero. The process involves:

  1. Correcting cash flows for the French plant loss by including the foregone output values.
  2. Ensuring the land sale in Year 10 is accurately reflected and that sunk costs of land are excluded.
  3. Calculating the NPVs and IRRs with these adjusted cash flows.
  4. Ranking projects based on their NPVs and IRRs to identify the most valuable investments.

Assuming no budget constraint, the projects would be recommended entirely based on positive NPVs and IRRs exceeding the WACC. The project with the highest NPV and IRR would be prioritized.

Analysis and Recommendations

Projects Without Budget Constraints

Under a no-budget scenario, the evaluation emphasizes selecting all projects with positive NPVs, as they add value to the firm. If multiple projects have positive NPVs, priority is given to those with higher NPVs and IRRs exceeding the WACC, as they provide the greatest return relative to their cost.

Limited Budget Constraints

With only €75 million available, a capital rationing approach is necessary. This involves selecting a combination of projects whose total investment does not exceed the budget while maximizing total value. Techniques such as linear programming or heuristic methods may be employed to optimize project selection, considering the NPVs and investment costs.

If the sale of land proceeds from the Brittany project are not reinvested, then the projects should be evaluated on their incremental cash flows. The land sale in Year 10 adds to project cash inflows but does not affect the initial investment. Thus, project selection focuses on negative or positive NPVs relative to their respective costs.

Conclusion

In conclusion, a thorough review of the projects' cash flows reveals the importance of accurately accounting for opportunity costs and sunk costs. Corrected NPVs and IRRs provide a solid basis for project ranking and selection. Under the constraints, CCR should prioritize projects that maximize value within its €75 million investment limit. Employing financial metrics alongside strategic considerations will enable optimal investment decisions, ensuring shareholder value creation.

References

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