MY STUDENT RESEARCH - HOME



KENNETH C HOLMESAPPLIED MANAGEMENT ACCOUNTINGPROFESSOR: JASON CADEFEBRUARY 1, 2015PHASE 3: INDIVIDUAL PROJECTMEMOTo: President of EECFrom: Kenneth C Holmes, EEC Financial AnalystSubject: Complete analysis of purchase of supplierTo prepare for the meeting finance has been asked to determine the feasibility of acquiring our supplier. Based on careful analysis and calculations, here are the results.EEC expects to save $500,000 per year for the next 10 years by purchasing the supplierEEC’s cost of capital is 14%EEC believes it can purchase the supplier for $2 millionNPV: after 10 years is + $608,057.82IRR: 21.41%Payback Period: 4 years Based on the calculations, my recommendation regarding the acquisition: Based on the calculations I believe the acquisition is a good investment for EEC. The total NPV for ten years is a positive $600,000, the IRR is 7% above the cost of capital, and it will only take four years to recover the investment. As long as the numbers prove reasonably accurate, the deal should prove to be a wise investment for EEC.The most useful tool, NPV, IRR or Payback Period: The NPV determines the present value of a projects projected future income. A positive NPV usually means you should accept the project and the higher the NPV the more acceptable. The IRR measures the rate of return of projected cash flows generated by the project, and indicates the breakeven point of a project. When the IRR exceeds the cost of capital it is a good investment. The payback period only indicates how long it will take to recover the investment in the project. You never want to use payback period as the deciding factor. Based on the three formulas, I believe the NPV is the best indicator. The NPV is most often easier to use, it assumes the rate of return is the discount rate that results in an NPV of zero, it makes more realistic assumptions about the rate of return cash flows from a project can earn, it can evaluate large long-term projects, and can be used with varying discount rates and cash flows. With the IRR you have to figure out the discount rate and it only uses one discount rate, it assumes the rate of return is the IRR of the project which is a bad assumption, it is more useful for short-term projects, and it cannot be used with varying cash flows or discount ratesThe least useful tool, NPV, IRR, or payback period:The payback period is the least useful method of evaluation because it only indicates how long it will take to recover the investment in the project. You never want to use payback period as the deciding factor. For that reason it is the least useful.If EEC’s cost of capital was 25%my answer would be: No, the IRR would be less than the cost of capital which would not cover the investment cost, and the NPV after 10 years is a -$214,748.36. At 25% cost of capital EEC is guaranteed to lose money.If EEC did not save $500,000 per year my answer would be:Payback Period: At $450,000 = 4.44 years to recoup initial investment At $400,000 = 5 years to recoup initial investment At $385,000 = 5.19 years to recoup initial investmentBased on the above figures, the lowest savings I would accept would be $400,000. At that savings the IRR is only 1% above the NPV, there is little room for error, and any major miscalculation could cause serious losses, and EEC is not in business to lose money. The least amount of savings that would make this investment attractive to EEC:Based on the calculations, the least amount of savings would be $400,000 per year. At that figure the NPV for 10 years is $86,000, the IRR is 1% above the cost of capital, the payback period is 5 years, and assumes the savings cannot go lower. At this savings there is little room for error. It is safe to say that EEC is not in business to lose money, and is not considering the acquisition to create a loss on the books. The most EEC should be willing to pay for the supplier: Based on the above calculations, the most EEC should consider paying is $2.5 million, the IRR is only 1% above cost of capital which does not provide much room for error, the payback period is 5 years, and assumes a $500,000 annual savings. At $2.6 million the IRR is even with the cost of capital, the payback period is 5.2 years, and assumes they will save $500,000 per year. If the savings fall below $500,000 EEC will absolutely lose money which is the purpose of the acquisition.REFERENCES BIBLIOGRAPHY \l 1033 Farid, S. (2014, March 26). Net Present Value Versus Internal Rate of Return Method. Retrieved from >Ner Present ValueN.A. (2015). Net Present value Calculator. Retrieved from calculator/netpresentvalue.aspxN.A. (2015). Phase 3 MUSE. Retrieved from ctuonline.eduRenaud, R. (2015). Which is a better measure for capital budgeting, IRR or NPV? Retrieved from ask/answers/05/irrvspnvcapitalbudgeting.asp ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download