Finance Mini Case
Mini Case Report – The Dilemma at Day-Pro 1) PayBack Period for Synthetic Resin and Epoxy Resin:
Synthetic Resin PBP = 2 + 250/200 = 2.5 years
Epoxy Resin PBP = 1 + 200/400 = 1.5 years
To show that using the Payback Period to evaluate the projects is flawed, Tim can argue that the PayBack Period ignores the time value of money, requires an arbitrary cutoff point, ignores cash flows beyond the cutoff date, and is biased against long-term projects, such as research and development, and new projects (Corporate Finance page 238).
2) Discounted payback Period (DPP) using 10% discount rate: Synthetic Resin DPP:
{1,000,000 – [(350,000)/(1 + 0.1)^1 + (400,000)/(1+0.1)^2]} x 100 = 35,124,100/375,657 = 93.5% of year 3
1 + 1 +0.935 =2.935
Epoxy Resin DPP:
{800,000 – [(600,000)/(1 + 0.1)^1]} x 100 = (800,000 – 545,454.5) x 100 = 25,454,550/330,578.5 = 77% of year 2.
1 +0.77= 1.77
Tim should not ask the Board to use DPP as the deciding factor because DPP does not provide a concrete decision criterion that can indicate whether the investment will increase the firm's value, it requires an estimate of the cost of capital in order to calculate the payback, and it ignores cash flows beyond the discounted payback period.
4) Synthetic Resin IRR = 37% Epoxy Resin IRR = 43%
IRR calculated using Excel
Tim can convince the board that IRR measure can be misleading by explaining that it may result in multiple answers with nonconventional cash flows and it may lead to incorrect decisions in comparisons of mutually exclusive investments.
5) Synthetic Resin NPV:
NPV = CI – CO
NPV = [(350,000)/(1 + 0.1)^1 + (400,000)/(1+0.1)^2 + (500,000)/(1 + 0.1)^3 + (650,000)/(1 + 0.1)^4 + (700,000)/(1 + 0.1)^5] – 1,000,000
NPV = 1,903,024 – 1,000,000
NPV = 903,024 Epoxy Resin NPV:
NPV = [(600,000)/(1 + 0.1)^1 + (400,000)/(1+0.1)^2 + (300,000)/(1 + 0.1)^3 + (200,000)/(1 + 0.1)^4 + (200,000)/(1 + 0.1)^5] – 1,000,000
NPV = 1,362,212 – 800,000
NPV = 562,212
The
Synthetic Resin PBP = 2 + 250/200 = 2.5 years
Epoxy Resin PBP = 1 + 200/400 = 1.5 years
To show that using the Payback Period to evaluate the projects is flawed, Tim can argue that the PayBack Period ignores the time value of money, requires an arbitrary cutoff point, ignores cash flows beyond the cutoff date, and is biased against long-term projects, such as research and development, and new projects (Corporate Finance page 238).
2) Discounted payback Period (DPP) using 10% discount rate: Synthetic Resin DPP:
{1,000,000 – [(350,000)/(1 + 0.1)^1 + (400,000)/(1+0.1)^2]} x 100 = 35,124,100/375,657 = 93.5% of year 3
1 + 1 +0.935 =2.935
Epoxy Resin DPP:
{800,000 – [(600,000)/(1 + 0.1)^1]} x 100 = (800,000 – 545,454.5) x 100 = 25,454,550/330,578.5 = 77% of year 2.
1 +0.77= 1.77
Tim should not ask the Board to use DPP as the deciding factor because DPP does not provide a concrete decision criterion that can indicate whether the investment will increase the firm's value, it requires an estimate of the cost of capital in order to calculate the payback, and it ignores cash flows beyond the discounted payback period.
4) Synthetic Resin IRR = 37% Epoxy Resin IRR = 43%
IRR calculated using Excel
Tim can convince the board that IRR measure can be misleading by explaining that it may result in multiple answers with nonconventional cash flows and it may lead to incorrect decisions in comparisons of mutually exclusive investments.
5) Synthetic Resin NPV:
NPV = CI – CO
NPV = [(350,000)/(1 + 0.1)^1 + (400,000)/(1+0.1)^2 + (500,000)/(1 + 0.1)^3 + (650,000)/(1 + 0.1)^4 + (700,000)/(1 + 0.1)^5] – 1,000,000
NPV = 1,903,024 – 1,000,000
NPV = 903,024 Epoxy Resin NPV:
NPV = [(600,000)/(1 + 0.1)^1 + (400,000)/(1+0.1)^2 + (300,000)/(1 + 0.1)^3 + (200,000)/(1 + 0.1)^4 + (200,000)/(1 + 0.1)^5] – 1,000,000
NPV = 1,362,212 – 800,000
NPV = 562,212
The