Fin20014 Evaluation Of Projects For Assessment Answer

Answer:

Introduction 

The document outlines two investment opportunity that is lying at the disposal of ALL CURE Inc. The projects are T-REC and P-REC. P-REC has not been clinically tested and the side impact of the same shall appear on the body pf persons who consume it while for T-REC, the probability of such mishap are less and no such side impact in long term. The report includes both quantitative analysis and qualitative analysis with greater focus on qualitative analysis.

Findings

Quantitative Findings (P-REC & T-REC) 

This part outlines the qualitative i.e numerical analysis of the P-REC & T-REC based on certain assumptions. The assumptions undertaken have been highlighted here-in-below: 

  • Training Expense incurred one shot by the company is treated as capital expenditure and the same is non- depreciable and non –tax deductible;
  • The estimated project duration is eight years and computation period is same;
  • The cost incurred for renovation is added to new equipment purchased;
  • Asset is disposed off post  8 years at loss;
  • Tax impact in sale of asset has been considered for analysis;
  • Increase in Working Capital has been recollected at the end of 8 years;
  • The expenditure incurred toward Research and Development during primary phase is non depreciable and non –tax deductible. The same is sunk cost of the company.
  • Bases on the stated assumptions, the quantitative analysis of P-REC & T-REC has been carried on the basis of four capital budgeting tools. The same has been enumerated here-in-below:

    • Discounted Payback period: In the said method of capital budgeting, the time value of money is considered and the cash flow earned over the life of the project is discounted to present value. Further, the analysis involves computation of time period in which the initial outlay shall be realised. The benchmark set by the company is 5 years and the said benchmarking is not satisfied for both the projects. 

    As far as P-REC is considered, it shall be seen based on the Appendix-1 that when the proposed inflow of cash has been discounted at 18% and 24% the discounted payback period of the project is 5.25 years and 6.43 years respectively and the same is greater than 5 years. A brief version of the said computation has been outlined here-in-below: 

    Sl NO

    Particulars

    Year 0

    Year 1

    Year 2

    Year 3

    Year 4

    Year 5

    Year 6

    Year 7

    Year 8

    Terminal Value

    1

    Operating Cash flow before Tax

    -2890000

    748060

    748060

    748060

    748060

    1336060

    1336060

    1336060

    1336060

    310000

    2

    Tax

     

    -224418

    -224418

    -224418

    -224418

    -400818

    -400818

    -400818

    -400818

    27600

    3

    Depreciation

     


    306000

    306000

    306000

    306000

    306000

    306000

    306000

    306000

     

    4

    Net Operating Cash flow

    -2890000

    829642

    829642

    829642

    829642

    1241242

    1241242

    1241242

    1241242

    337600

    5

    Discounting Factor @18%

    1

    0.847458

    0.718184

    0.608631

    0.515789

    0.437109

    0.370432

    0.313925

    0.266038

    0.266038164

    6

    Discounted Cash Flow

    -2890000

    703086.4

    595836

    504945.7

    427920.1

    542558.3

    459795.2

    389656.9

    330217.7

    89814.48408

    7

    Net Present Value

    1153831

     

     

     

     

     

     

     

     

     

    8

    Cumulative

    -2890000

    -2186914

    -1591078

    -1086132

    -658212

    -115653

    344141.8

    733798.7

    1064016

    1153830.921

    9

    Discounted Pay back period

     

     

     

     

     

     

    5.251532

     

     

     

    10

    Discounting Factor @24%

    1

    0.806452

    0.650364

    0.524487

    0.422974

    0.341108

    0.275087

    0.221844

    0.178907

    0.178906664

    11

    Cumulative

    -2890000

    -2220934

    -1681364

    -1246228

    -895311

    -471914

    -130464

    144898

    366964.4

    427363.3353

    12

    Discounted Pay back period

     

     

     

     

     

     

     

    6.473792

     

     

    On the other hand for T-REC,  it shall be pertinent to note that discounted payback period is beyond 8 years when project is discounted @24% while the same is 7.024 years when discounted @18% (Anon., 2018). A brief computation has been outlined here in-under: 

    Computation of Net Present Value for T-REC

    Sl NO

    Particulars

    Year 0

    Year 1

    Year 2

    Year 3

    Year 4

    Year 5

    Year 6

    Year 7

    Year 8

    Terminal Value

    1

    Net cash flow

    -2890000

    956300

    922000

    766600

    618200

    578300

    560800

    535600

    504800

    337600

    2

    Discounting Factor @18%

    1

    0.847457627

    0.718184

    0.608631

    0.515789

    0.437109

    0.370432

    0.313925

    0.266038

    0.266038164

    3

    Discounted Cash Flow

    -2890000

    810423.7288

    662166

    466576.4

    318860.7

    252780.3

    207738

    168138.2

    134296.1

    89814.48408

    4

    Cumulative

    -2890000

    -2079576.271

    -1417410

    -950834

    -631973

    -379193

    -171455

    -3316.6

    130979.5

    220793.9465

    5

    Discounted Payback period

     

     

     

     

     

     

     

     

    7.024696

     

    6

    Discounting Factor @24%

    1

    0.806451613

    0.650364

    0.524487

    0.422974

    0.341108

    0.275087

    0.221844

    0.178907

    0.178906664

    7

    Discounted Cash Flow

    -2890000

    771209.6774

    599635.8

    402071.9

    261482.3

    197262.6

    154268.7

    118819.8

    90312.08

    60398.88991

    8

    Cumulative

    -2890000

    -2118790.323

    -1519155

    -1117083

    -855600

    -658338

    -504069

    -385249

    -294937

    -234538.2196

    9

    Discounted Payback period

    Never Paid off

    Net Present Value: Net present Value is the most important tool under capital budgeting. In the said tool the discounted cash flow realised over the life of the project is reduced from the initial outlay. If the NPV is positive, the project is viable otherwise not. Further, the higher the value of NPV, the viable the project is. In addition, the rate for discounting the project shall be the project cost of capital.(CFI Education Inc., 2018)The simple formula for Net Present Value has been stated here-in-below: 

    Net Present Value = Present value of Inflows – Present Value of Out flows. 

    As far as P-REC is considered, it shall be seen based on the Appendix-1 that when the proposed inflow of cash has been discounted at 18% and 24% the NPV of the project is $ 1,153,831 and $427,363 respectively A brief version of the said computation has been outlined here-in-below:

    Year

    Cash flows @18%

    Cash flows @24%

    0

    -2890000

    -2890000

    1

    703086

    669066

    2

    595836

    539569

    3

    504946

    435137

    4

    427920

    350917

    5

    542558

    423397

    6

    459795

    341449

    7

    389657

    275362

    8

    420032

    282465

    Total

    1153831

    427363

    On perusal it can be seen that P-REC has positive net present value under both 18% and 24% discounting rate.

    On the other hand for T-REC,  it shall be pertinent to note that Net Present Value is negative when project is discounted @24% and stands at  -$2,34,538/-  while the same is $2,20,794/- when discounted @18%. A brief computation has been outlined here in-under: 

    Year

    Cash flow @18%

    Cash flow @24%

    0

    -2890000

    -2890000

    1

    810423.7288

    771209.6774

    2

    662166.0442

    599635.796

    3

    466576.427

    402071.9345

    4

    318860.6826

    261482.2782

    5

    252780.2597

    197262.6061

    6

    207738.0072

    154268.7264

    7

    168138.2478

    118819.7877

    8

    224110.5491

    150710.9741

    Total

    220793.9465

    -234538.2196

    On perusal it can be seen that T-REC has positive net present value under 18% discounting rate and it is not feasible @24% discounting rate 

    • Internal Rate of Return:  The third parameter for analysis is Internal Rate of Return, In the said method , the cash flows are discounted ta a rate by which the present value of inflows from the proposed project shall stand equal to initial outlay made in the project. (CFI Education Inc., 2018)The simple formula for the said methodology has been presented here-in-below’: 

    Present Value of Cash outflow on the project= Present Value of inflows from the project at a discounting rate which is equal to internal rate of return. 

    On the basis of above methodology, the discounting rate at which inflow is equal to outflow for P-REC is 28%. The brief overview of the same has been highlighted here-in-under: 

    Year

    Cash Flows

    0

    -2890000

    1

    829642

    2

    829642

    3

    829642

    4

    829642

    5

    1241242

    6

    1241242

    7

    1241242

    8

    1473242

    IRR

    28%

    IRR of project is greater than 24% and hence feasible. 

    While on the other hand, the IRR for T-REC is 21%. The brief overview of the same has been highlighted here-in-under: 

    Year

    Cash Flows

    0

    -2890000

    1

    956300

    2

    922000

    3

    766600

    4

    618200

    5

    578300

    6

    560800

    7

    535600

    8

    842400

    IRR

    21%

    IRR of project is less than 24% and hence not feasible. 

    • Profitability Index:  The last tool used for analysing the proposed investment is Profitability Index under which Present Value of inflow is divided by present value of outflow. If, the result obtained is greater than 1, the project is feasible otherwise the same shall not be considered.(AccountingExplained.com , 2013) 

    As far as P-REC is considered, it shall be seen based on the Appendix-1 that when the proposed inflow of cash has been discounted at 18% and 24% the PI of the project is 1.399 and 1.148 respectively. 

    As far as T-REC is considered, it shall be seen based on the Appendix-1 that when the proposed inflow of cash has been discounted at 18% and 24% the PI of the project is 1.076 and .9188 respectively. 

    In the case of T-REC discounting has been carried at two rates i.e. 18% and 24% and accordingly the PI of the project stands at 1.076 and .9188 respectively. 

    Accordingly, it shall be concluded that T-REC is not feasible @ 24% discounting rate. 

    Qualitative Findings 

    While analysing the qualitative factors of the project, it shall be pertinent to note that the same is based on probable impact that factors like management, government etc have on the proposed project. Further, in the present case the analysis has been limited to long term impact of the project and proposed issues that might crop up in case of failure. The same has been highlighted here-in-below: 

    • As far as P-REC is considered, the same is in grafted with a major risk that it has not been clinically 100% sound proof and the same is in budding stage. Launching P-REC in the market at such a stage without knowing the probable side impact of such medicine can unleash a range of problems in the company.
    • In addition to above, if the problem broke out in the middle of the duration of the project the same shall impact the cash flow detailed in the appendix;
    • In case of P-REC also there shall be litigation and dispute if the side impact are developed in consumers and may have huge penalty on the company dangering its continuous existence in the long run;
    • Pharmaceutical Sector has been prone to litigation  and strict regulation , thus taking such risk for short term benefit shall not be viable
    • As far as T-REC is considered, it is proven and tested and launching the same is safe;
    • Goodwill of the company shall be impacted in the long run if the project fails.

    Recommendation and Justifications 

    On the basis of above, it shall be concluded that though P-REC seems profitable and better than T-REC on quantitative front while the same may not be feasible on the qualitative factor and may tarnish the image of the company in the long run. Accordingly, the same is not feasible and T-REC shall be produced if the cost of capital is less than 21%  

    Detail Comparison and Further Recommendation 

    Further, a detail comparison of quantitative analysis is described here-in-under:

    Sl No

    Particular

    P-REC

    T-REC

    1

    Discounted Pay Back period @18%

    5.251532

    7.024696201

    2

    Discounted Pay Back period @24%

    6.473792

    Never Paid off

    3

    Net Present Value @18%

    1153831

    220793.9465

    4

    Net Present Value @24%

    427363.3

    -234538.2196

    5

    Internal Rate of Return

    28%

    22%

    6

    Profitability Index @18%

    1.40

    1.08

    7

    Profitability Index @24%

    1.15

    0.92

    The company shall consider long run and shall produce T-REC even though the same is less feasible on monetary as presented above as the same has very less risk compared to P-REC

    Conclusion 

    Company shall produce T-REC based on reason stated above. Further, the company shall thing of long term vision and carry on research on P-REC to develop it further before launching the same in the market as Pharmaceutical sector is prone to litigation and risk measures.

    References:

    AccountingExplained.com , 2013. Profitability Index. [Online]  Available at: https://accountingexplained.com/managerial/capital-budgeting/profitability-index [Accessed 2 October 2018].

    Anon., 2018. Payback Period & Discounted Payback Period | Formula | Example. [Online]  Available at: https://www.wallstreetmojo.com/payback-period-discounted-payback-period/ [Accessed 1 October 2018].

    CFI Education Inc., 2018. Internal Rate of Return (IRR). [Online] Available at: https://corporatefinanceinstitute.com/resources/knowledge/finance/internal-rate-return-irr/
    [Accessed 2 October 2018].

    CFI Education Inc., 2018. Net Present Value (NPV). [Online]  Available at: https://corporatefinanceinstitute.com/resources/knowledge/valuation/net-present-value-npv/
    [Accessed 2 October 2018].

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