Submissions: 1 Excel Spreadsheet And 1 Paper Of 1750 Part 1

2 Submissions 1 Excel Spreadsheet And 1 Paper Of 1750part 1the Presi

Part 1: The President of EEC recently called a meeting to announce that one of the firm’s largest suppliers of component parts has approached EEC about a possible purchase of the supplier. The President has requested that you and your staff analyze the feasibility of acquiring this supplier. Discuss the following: What information will you and your staff need to analyze this investment opportunity? What will be your decision-making process? Discuss and evaluate the different techniques that could be used in capital budgeting decisions. Specifically, discuss how the time value of money affects capital budgeting. Capital budgeting differs from regular budgeting in that capital budgeting is for large investment decisions like plant expansion. The regular budgeting is for your day-to-day operations decisions. Which do you think EEC should use? Why?

Part 2: Based on the following information, calculate net present value (NPV), internal rate of return (IRR), and payback for the investment opportunity: EEC expects to save $500,000 per year for the next 10 years by purchasing the supplier. EEC’s cost of capital is 14%. EEC believes it can purchase the supplier for $2 million. Answer the following: Based on your calculations, should EEC acquire the supplier? Why or why not? Which of the techniques (NPV, IRR, or payback period) is the most useful tool to use? Why? Which of the techniques (NPV, IRR, or payback period) is the least useful tool to use? Why? Would your answer be the same if EEC’s cost of capital were 25%? Why or why not? Would your answer be the same if EEC did not save $500,000 per year as anticipated? What would be the least amount of savings that would make this investment attractive to EEC? Given this scenario, what is the most EEC would be willing to pay for the supplier? Prepare a memo to the President of EEC that details your findings and shows the effects if any of the following situations are true: EEC’s cost of capital increases. The expected savings are less than $500,000 per year. EEC must pay more than $2 million for the supplier.

Paper For Above instruction

Introduction

Financial decision-making in corporate settings heavily relies on capital budgeting techniques to evaluate large investments. For EEC, acquiring a key supplier presents a strategic opportunity that warrants rigorous financial analysis. This paper explores the key informational requirements, decision-making processes, and evaluation techniques pertinent to this acquisition, emphasizing the impact of the time value of money. Additionally, it includes a detailed financial analysis based on provided data, assessing whether the purchase aligns with EEC’s financial goals and strategic interests.

Part 1: Analyzing the Investment Opportunity

Information Required for Feasibility Analysis

To assess the viability of acquiring the supplier, EEC’s team needs comprehensive information. First and foremost, detailed financial statements of the supplier, including income statements, balance sheets, and cash flow statements, are essential to understand the supplier’s current financial health. Historical financial performance, debt levels, profit margins, asset valuations, and cash flow stability provide critical insights into operational sustainability and potential risks.

Market position and industry outlook for the supplier are also vital, including competitive positioning, customer base, and industry growth trends. Understanding the supplier’s operational efficiencies, production costs, and potential integration costs with EEC would further inform the valuation. Additionally, legal, regulatory, and contractual obligations, such as existing supplier agreements or potential liabilities, must be reviewed.

Furthermore, projection of future cash flows and savings resulting from the acquisition are vital for financial modeling. EEC needs to assess potential synergies, cost reductions, or revenue enhancements that could arise from the purchase. A comprehensive risk analysis, including supplier dependency, supply chain disruptions, and market volatility, will deepen the evaluation.

Decision-Making Process & Techniques

Decision-making in capital budgeting involves several systematic steps. It begins with identifying the investment opportunity and gathering relevant financial and non-financial data. Next, forecasting cash flows—both inflows and outflows—over the investment’s useful life is essential. The subsequent step involves selecting appropriate evaluation techniques to appraise the project’s value.

Common techniques include Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period, and occasionally, Discounted Payback Period and Profitability Index. NPV constitutes the cornerstone, representing the difference between the present value of cash inflows and outflows, discounted at the company’s cost of capital. IRR indicates the discount rate at which the project’s NPV becomes zero, providing a rate-of-return perspective. The payback period assesses how quickly initial investment is recovered, emphasizing liquidity and risk exposure rather than profitability.

Impact of Time Value of Money

Time value of money (TVM) is fundamental to sound capital budgeting. It reflects the principle that money received today is worth more than the same amount received in the future due to its potential earning capacity. Discounting future cash flows accounts for inflation, risk, and opportunity cost, thereby providing a realistic evaluation of an investment’s worth.

For large projects like plant expansion, which involve substantial capital outlays over long periods, TVM makes it possible to compare cash flows occurring at different times on a standardized basis. Ignoring TVM can lead to overestimating the attractiveness of long-term investments or undervaluing future risks.

Recommendation on Budgeting Approach

EEC faces a strategic decision: whether to adopt capital budgeting techniques or rely on regular operational budgets for the acquisition. Given the scale and long-term impact of acquiring a supplier, capital budgeting methods such as NPV and IRR are more appropriate because they account for TVM and provide a profit-based evaluation. Regular budgets, focused on short-term operational expenses, lack the capacity to capture the value of large-scale investments over time.

Therefore, EEC should primarily use capital budgeting evaluations for this investment decision to ensure comprehensive financial analysis aligned with long-term strategic goals.

Part 2: Financial Evaluation of the Investment

Parameters and Calculations

Given data: Annual savings = $500,000; Project duration = 10 years; Cost of capital = 14%; Purchase price = $2 million.

Net Present Value (NPV)

The NPV calculation discounts the annual savings over 10 years at 14% and deducts the initial cost.

• Present value of savings:

PV = $500,000 × [ (1 - (1 + 0.14)^-10) / 0.14 ] ≈ $500,000 × 5.2161 ≈ $2,608,050

• NPV = PV of savings - Initial investment

NPV ≈ $2,608,050 - $2,000,000 = $608,050

Internal Rate of Return (IRR)

The IRR is the discount rate where NPV equals zero. Using financial calculator or software, IRR is approximately 20.1%, indicating the project's yield exceeds the cost of capital (14%).

Payback Period

The payback period is the time required to recover the initial investment from cash inflows:

Payback = $2,000,000 / $500,000 = 4 years

Decision & Analysis

Based on the NPV being positive, IRR exceeding the discount rate, and payback within half the project duration, the acquisition appears financially viable. EEC should consider proceeding with the purchase.

Comparison of Techniques & Sensitivity Analysis

The NPV is generally considered the most comprehensive evaluation tool because it accounts for the magnitude, timing, and risk-adjusted discounting of cash flows. IRR provides a rate of return, useful for comparison to other projects, but can sometimes be misleading if cash flows are unconventional. The payback period emphasizes liquidity and risk but ignores the time value beyond the payback point and profitability.

At a higher cost of capital, for instance, 25%, the NPV would decrease, possibly turning negative, which would make the project less attractive. If the expected savings were less than $500,000 annually, the minimum savings required for project acceptance can be calculated by setting NPV to zero and solving for savings:

Savings = Initial Investment × Discount Rate / [1 - (1 + discount rate)^-n] ≈ $2,000,000 × 0.14 / 5.2161 ≈ $537,000

Thus, the project remains attractive if annual savings are at least approximately $537,000.

Finally, the maximum EEC would be willing to pay for the supplier can be approximated by the present value of future savings, roughly $2.6 million at 14%. Any amount below this would make the investment profitable.

Conclusion

The analysis indicates that acquiring the supplier is a financially sound decision for EEC under the given assumptions. Capital budgeting techniques such as NPV and IRR provide robust frameworks for evaluating large investments, with NPV being the most comprehensive. Sensitivity analyses underscore the importance of accurate estimates of savings and costs, as well as the impact of changes in discount rates. EEC should proceed with the acquisition if assumptions hold and should continually monitor key variables to ensure the investment remains viable.

References

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