Financial Analysis project 2015 FINAL FINAL
alba graduate business school
Financial Analysis
Case Study in Capital Budgeting
Dinas Vadel Inc.
Bala Iro Boura Perry Fakitsas Christos Politis Stathis
PART A : DINAS VADEL CASE
1. Define the term “incremental cash flow”. Since the project will be financed in part by debt, should the cash flow analysis include the interest expense? Explain
Incremental cash flow refers to the extra cash flow the company will generate from taking on a new project. It is the difference between the company’s cash flow with the project and without the project.
In the Divas Vadel case there are several aspects of the expansion project that must be taken into consideration when identifying incremental cash flows. In our case for example the initial investment outlay, cash flows from operations, changes in working capital, terminal cost, opportunity cost and externalities must be taken into account.
The cash flow analysis should not include interest expense. In order to calculate the NPV of a project the cash flows are discounted with the cost of capital rate (WACC). The cost of capital rate (WACC) is a weighted average of the costs of debt and common equity. The cost of debt contains the interest expense (Kd). Thus when discounting the cash flows with WACC we are subtracting the interest expenses. If we where to include the interest expenses in our cash flow analysis we would end up double-counting this cost. This would create different results than reality and mislead the final decision.
2. What would happen if the project is financed entirely debt? Explain
In general debt is more attractive than equity because it is less expensive money overall. This because the creditors ask for securities (cash collateral or mortgages) and the interest payments are included in the expense accounts thus they are non taxable.
In Dinas Vadel case, other things been equal when the project is financed entirely by debt this would change the WACC. In this case the WACC becomes equal to 6%,
Financial Analysis
Case Study in Capital Budgeting
Dinas Vadel Inc.
Bala Iro Boura Perry Fakitsas Christos Politis Stathis
PART A : DINAS VADEL CASE
1. Define the term “incremental cash flow”. Since the project will be financed in part by debt, should the cash flow analysis include the interest expense? Explain
Incremental cash flow refers to the extra cash flow the company will generate from taking on a new project. It is the difference between the company’s cash flow with the project and without the project.
In the Divas Vadel case there are several aspects of the expansion project that must be taken into consideration when identifying incremental cash flows. In our case for example the initial investment outlay, cash flows from operations, changes in working capital, terminal cost, opportunity cost and externalities must be taken into account.
The cash flow analysis should not include interest expense. In order to calculate the NPV of a project the cash flows are discounted with the cost of capital rate (WACC). The cost of capital rate (WACC) is a weighted average of the costs of debt and common equity. The cost of debt contains the interest expense (Kd). Thus when discounting the cash flows with WACC we are subtracting the interest expenses. If we where to include the interest expenses in our cash flow analysis we would end up double-counting this cost. This would create different results than reality and mislead the final decision.
2. What would happen if the project is financed entirely debt? Explain
In general debt is more attractive than equity because it is less expensive money overall. This because the creditors ask for securities (cash collateral or mortgages) and the interest payments are included in the expense accounts thus they are non taxable.
In Dinas Vadel case, other things been equal when the project is financed entirely by debt this would change the WACC. In this case the WACC becomes equal to 6%,