Capital Investment Analysis: Roman Manufacturing Company

Introduction

The main aim of this assignment is relating to capital budgeting and the application of different techniques applied on the same aspect. There are three different ventures which have been selected in the same outcome that needed to be managed and analysed properly on the basis of NPV, IRR and Payback

Net Present Value

Net Present Value (NPV) is an important and valuable tool which consider by the organisations for the purpose of evaluating different proposals of investment. On the basis of the same analysis, a specific one will be selected for the same purpose. NPV is a tool in which the future value will be discounted on the present value, and then analyse it in accordance with the initial outlay. The basis of selection of the proposal on NPV is clear, as when the NPV is in the positive node, the proposal of the investment should be selected, which is quite obvious and efficient. On the other hand, it should be rejected. This particular aspect is very authentic and efficient for Roman Manufacturing Company (RMC), which is likely to analyse three different ventures, such as Casual Shoes, Athletic Shoes and House of Napoli Shoes. Each of these segments have their cost and associated benefits. Hence, it is essential to analyse each of the venture accordingly.

From the aforementioned table, it is clearly found that the first option is the proposal of Casual Shoes which has an initial outlay of $3.25 Million. The cash flow of the same proposal is in the zigzag direction, however it turns in the positive node at the end of the period. A total of ten years of analysis have been taken into the consideration for the same analysis, with each of the analysis has its effectiveness and positivity. The discounting factor is 10% which has been considered for the same analysis. After the subtraction of the initial outlay from the total discounted cash flow which has been discounted on the basis of 10%, it comes in the positive node. The NPV comes positively which is 0.334$ Million, which is quite efficient. Based on the same aspect and output, it can be said that the investment would be essential and effective for the company, if it is selected and executed by the company for their future development and effectiveness.

Secondly, it is clearly found that the 2nd option is the proposal of Athletic Shoes which has an initial outlay of $2.25 Million. The cash flow of the same proposal is in the zigzag direction, however it turns in the positive node at the end of the period. A total of ten years of analysis have been taken into the consideration for the same analysis, with each of the analysis has its effectiveness and positivity. The discounting factor is 10% which has been considered for the same analysis. After the subtraction of the initial outlay from the total discounted cash flow which has been discounted on the basis of 10%, it comes in the positive node. The NPV comes positively which is 2.97$ Million, which is quite efficient. Based on the same aspect and output, it can be said that the investment would be essential and effective for the company, if it is selected and executed by the company for their future development and effectiveness.

Finally, come to the third option which is the proposal of house of Napoli which has an initial outlay of $5 Million. The cash flow of the same proposal is in the zigzag direction, however it turns in the positive node at the end of the period. A total of ten years of analysis have been taken into the consideration for the same analysis, with each of the analysis has its effectiveness and positivity. The discounting factor is 10% which has been considered for the same analysis. After the subtraction of the initial outlay from the total discounted cash flow which has been discounted on the basis of 10%, it comes in the positive node. The NPV comes positively which is 15.46$ Million, which is quite efficient. Based on the same aspect and output, it can be said that the investment would be essential and effective for the company, if it is selected and executed by the company for their future development and effectiveness.

Selection or rejection

From the analysis, it is found that each of these options is effective and proficient for the company because of positive NPV. However, for the mutual exclusive, the one with the highest NPV should be selected, which is the 3rd option, such as House of Napoli. Based on the same outcome, this particular option should have been selected accordingly.

Internal Rate of Return

IRR is yet another important tool which has been used and selected for the purpose of same analysis. IRR is define as a tool in which the NPV of the company would become Zero, and it is an important and most efficient tool uses for capital budgeting. The criteria of selecting the project on the basis of IRR is quite simple, as if the IRR is higher than the actual discounting rate, then it should be selected otherwise it should be rejected. The IRR of each of the selected proposals are as follows

The first column of the analysis is showing the IRR based value of Causal Shoes, which comes in the positive node. The IRR of the same is 11%, which is relatively higher than the actual discounted rate of the option which is 10%. Comparing the result with the hurdle rate, it can be said that the proposal is effective, and it has the ability to generate positive cash flow towards the company, and it has the tandem to be selected by the company for the investment purpose. Hence, it is essential for their productivity and efficiency based on the same outcome.

The 2nd column of the analysis is showing the IRR based value of Athletic Shoes, which comes in the positive node. The IRR of the same is 36%, which is extremely higher than the actual discounted rate of the option which is 10%. Comparing the result with the hurdle rate, it can be said that the proposal is effective, and it has the ability to generate positive cash flow towards the company, and it has the tandem to be selected by the company for the investment purpose. Hence, it is essential for their productivity and efficiency based on the same outcome.

Finally the 3rd column of the analysis is showing the IRR based value of House of Napoli Shoes, which comes in the positive node. The IRR of the same is 43%, which is extremely higher than the actual discounted rate of the option which is 10%. Comparing the result with the hurdle rate, it can be said that the proposal is effective, and it has the ability to generate positive cash flow towards the company, and it has the tandem to be selected by the company for the investment purpose. Hence, it is essential for their productivity and efficiency based on the same outcome.

Selection or rejection

From the analysis, it is found that each of these options is effective and proficient for the company because of higher IRR. However, for the mutual exclusive, the one with the highest IRR should be selected, which is the 3rd option, such as House of Napoli. Based on the same outcome, this particular option should have been selected accordingly.

Payback Period Analysis

Apart from NPV and IRR, there is yet another major tool which used for the purpose of Capital Budgeting known as Payback Period Analysis. It based its decision on the basis of netting off the actual investment of the company accordingly. The Payback Period of each of the three options are as follows

Firstly, the payback of Casual Shoes has been analysed in which it is found that in how many years, the proposal can netting off its original cost. Payback Period of a proposal should be locating on a lower scale, in order to get the maximum output from the same. From the same analysis, it is found that in 7.25 years, the entire cost of this proposal can be overcome.

Secondly, the payback of Athletic Shoes has been analysed in which it is found that in how many years, the proposal can netting off its original cost. Payback Period of a proposal should be locating on a lower scale, in order to get the maximum output from the same. From the same analysis, it is found that in 2.8 years, the entire cost of this proposal can be overcome.

Finally, the payback of House of Napoli Shoes has been analysed in which it is found that in how many years, the proposal can netting off its original cost. Payback Period of a proposal should be locating on a lower scale, in order to get the maximum output from the same. From the same analysis, it is found that in 3.5 years, the entire cost of this proposal can be overcome.

Selection or Rejection

There is a criteria has been given of 3 years, in which the analysis have been found. Based on the same output and outcome, the second option which is Athletic Shoes should have been selected which has a payback of 2.8 years, which is lower than the period of 3 years in particular.

Required Rate of Return on Equity

This particular part of the assignment is relating to compute the required rate of return on the equity. This should be analysed through the Capital Asset Pricing Model (CAPM). It is required to analyse the CAPM on the venture of House of Napoli.

CAPM = Risk Free Rate + Beta * (Market Return – Risk Free Rate)

= 3% + 1.25 * (9% – 3%)

Required Rate of Return = 10.5%

Hence, this particular amount should have been gauged by the company in order to maximise their potential accordingly.

Cost of Debt

Cost of Debt is likely to analyse in this particular outcome in particular. Cost of Debt which has been found from the same case is 3.3%, which is after tax. The tax rate is 34%, which already been enforced and applied in the same outcome. Hence, this particular factor should be managed accordingly.

WACC

This particular part of the assignment is likely to compute the weighted average cost of capital (WACC) of the same analysis. Considering the aforementioned cost of debt and cost of equity into the consideration.

WACC = Cost of debt * Proportion + Cost of Equity * Proportion

= 3.3% * 49% + 10.5% * 51% = 6.97%

Hence the WACC is 6.972%, which is quite efficient and locating in a respective position.

Correct Decision

There are three different proposals which have been selected and analysed in the entire aspect. The three different tools which have selected for the same aspect is NPV, IRR and Payback. Each of these tools have its own pros and cons. The NPV of House of Napoli is the highest accompanied with the IRR, which is eyeing towards the selection of the same output. On the other hand, the payback of Athletic Shoes is the lowest, showing that in a matter of less than three years the company can overcome its cost, which is quite efficient in the long run. NPV and IRR is the best available tool that uses for the purpose of Capital Investment, and taking capital decisions, which is quite obvious and efficient in the long run. Based on the same scenario, the rule which the company has to follow is to surrender in front of NPV and IRR, which is pointing out that the project of House of Napoli would be the ideal and most beneficial one for the company as far as increasing its financial outcome is concerned. Since the project is mutually exclusive, therefore, this is the only project in which the company has to undertake the decision for their effectiveness and betterment instead of any other project discussed in the case.

Questions to consider?

One of the main question that should be consider in the same output is relating to the probability of variation. It means that the management should be asked if the cash flow will remain like the same as it is anticipated, because variation may exist and may increases with the passage of time. However, in this particular case, the variation of the cash flow should be locating on a specific scale, otherwise things will go totally wrong for the company in the long. Hence, this particular outcome should be consider by the company.

Ventures Purchased

From the analysis, it is clearly found that each of these three ventures are effective and quite favourable for the company, as they have the ability to increase the financial outcome of the company accordingly. Hence, each of these projects can be selected. But, the projects are mutually exclusive, which means that only one of them should be selected by the company. Based on the same analysis and output, it can be said that House of Napoli is the venture that should be selected. The main justification of selecting this venture is their higher NPV and IRR than other two ventures mentioned and prescribed in the Case study. NPV and IRR is the best available tool that uses for the purpose of Capital Investment, and taking capital decisions, which is quite obvious and efficient in the long run. Based on the same scenario, the rule which the company has to follow is to surrender in front of NPV and IRR, which is pointing out that the project of House of Napoli would be the ideal and most beneficial one for the company as far as increasing its financial outcome is concerned. Hence, the decision would be ideal for the company.

Conclusion

The main aim of this assignment is relating to capital budgeting and the application of different techniques applied on the same aspect. From the analysis, it is found that the last option or venture of House of Napoli would be essential for the company in the long run, and they should select the same.

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