Capital Budgeting Financial Management- FIN 534 Problem 23A For the base-case scenario, what is the NPV of the plant to manufacture lightweight trucks? Bauer Industries is an automobile manufacturer.
Like any other company, the management team is considering making an investment and must consider all aspect before accepting a proposal. Bauer Industries must evaluate their proposal to build a plant that will manufacture lightweight trucks. The company has set a 12% cost of capital.IT is important that the proposal has positive NPV or it will not be a smart business move for Bauer Industries.
NPV is defined as the difference between the present value of its benefits and the present value of its cost. The formula used to calculate net present value is NPV=PV (benefits)-PV (costs). Many companies consider the formula the golden rule for financial decision making. Decision makers look for positive NPV or the investment is not considered. In this case, the NPV of the plant to manufacture lightweight trucks is positive.
NPV=-150 x 36 x 1. 2(1-11-12x9)+481. 12x10=57. 3 million Problem 23B What is the NPV of this project if revenues are 10% higher than forecast? What is the NPV if revenues are 10% lower than forecast? Sensitivity analysis is another great capital budgeting tool to use when evaluating investments or making business decisions within a firm or company. If a company use the sensitivity analysis, the company are able to divide the NPV calculations into different groups of assumptions.
This process then will show how NPV varies to change. This can either be positive or negative.While Bauer Industries are considering this venture, they are smart to be uncertain about their projected assumptions when in reality their forecast could generate totally opposite results. The sensitivity analysis also gives data that can be used to determine which assumptions are most important. This will allow Bauer Industries to invest and refine their numbers and assumptions to make them realistic.
Below will show what the NPV of Bauer project if revenues were 10% higher and will if revenues were 10% lower than forecast. Sales10% LowerActual 10% Higher 90 100 110NPV 20. 5 57. 3 94. Problem 23C Bauer Industries has a strong financial business sense as they are considering the most important factors will determining this venture. It is important that Bauer evaluate the sensitivity analysis to the possible growth in revenues and operating expenses.
Bauer industries are assuming revenues and expenses will increase by just 2%. In my opinion, that is a very conservative number. It would be great if the initial capital and expenditures would stay the same as the company projects but several factors can arise and offset their budget.Remember the NPV of the estimate free cash flow is $57. 3 million.
Bauer Industries now wants to assume in the second year, revenues, manufacturing and marketing expenses will increase by 2% and later assumes an increase of 5%. Under this alternate assumption, a different outcome will project. With a 2% growth rate the NPV would increase to 72. 5.
Under the 5% assumption rule the NPV would be 98. 1. In terms of evaluating this investment, Bauer Industries should proceed with their original plans. Problem 23DCreate a graph, with the discount rate on the x-axis and the NPV on the y-axis, for discount rates ranging from 5% to 30%. For what ranges of discount rates does the project have a positive NPV? Below is a graph showing the discount rate on the x-axis and the NPV on the y-axis. Discounts ranged from 5% to 30%.
It also show that NPV would be positive if about the discount rate is below 20. Reference Berk, J. , & DeMarzo, P. (2011).
Corporate finance: The Core: 2010 custom edition. (2nd ed. ) Boston: Pearson Education.
