Topics: Net present value, Internal rate of return, Investment Pages: 5 (1169 words) Published: May 26, 2013
Course Project Part II

AirJet Best Parts Financial Analysis

A financial decision for the purchase of new equipment will be based on the projects IRR and NVP. Below I have included the IRR and NPV to help assist in the financial decisions for the project.

Capital budgeting for a new machine

1.) The IRR is 22.38%

2.) The NVP is $450,867.00

NVP formula is as followed:

Year 1 = 1100000/(1+0.15)^1 = 1100000/1.15 = 956521.74
Year 2 = 1450000/(1+0.15)^2 = 1450000/1.3225 = 1096408.32
Year 3 = 1300000/(1+0.15)^3 = 1300000/1.52087 = 854771.1
Year 4 = 950000/(1+0.15)^4 = 950000/1.74901 = 543165.58

Year| Cash flow| x15%| Present Value|
1| 1,100,000| 0.8696| $956,522|
2| 1,450,000| 0.7561| $1,096,408|
3| 1,300,000| 0.6575| $854,771|
4| 950,000| 0.5718| $543,166|
| | | |
| | Total| (3,000,000)|
| | NVP| $450,867.00|

3.) In my opinion the company should accept the project based on the financial gain of the project.

4.) Depreciation can have varying affects on different projects. In the case of this project depreciation would actually be a positive thing. Deprecation in an accounting income typically does not reduce cash flows. In fact, they can have a significant positive impact on cash flows, if they affect the tax liability of the firm. In this case it would be positive for the company because it would save on taxes while increasing present value.

5.) Examples as related to the project:

a. Sunk cost- A cost that cannot be recovered because the funds are already spent. An example of a sunk cost for AirJet best Parts could be: AirJets Best made an investment of $500,000 to provide project research through an extensive survey. This would be a sunk cost because once the survey was completed the money could not be recovered.

b. Opportunity Cost- This is the cost of giving up one thing for another. An example of opportunity cost for AirJet Best could be the company providing other companies with partial repair services for a year with a minimal cost with hopes of making more money by providing full service repairs to returning customers.

c. Erosion- A negative impact on one or more of a company’s existing assets. An example of this could be: AirJet Best stocks were trading at a rate of $100 over a said period. During this time AirJet production on a popular item has come to a halt because the company is out of stock on a key component of the part. They are unable to receive the part for 2 days resulting in a drop of 15%. This would be an example of erosion or depreciation.

6.) While conducting a scenario and sensitivity analysis of the project I would first compute the NVP for any changes that occurred within the cash flow. Some project specific risks could include defects in the new project equipment or not yielding the desired results with the equipment. Market risks usually arise from the lack of demand for a certain product or service, changing industry structures, or pricing instability. Related market risks could include: a change in the demand of the special component that is being produced by the new machinery.

Cost of Capital

1.) Cost of debt

a. Competitor YTM rate of Boeing is 2.39
b. 2.39 x 34% = .81% - 5.50% =(4.69%)
c. The YTM could have been utilized, allowing the company to estimate the return on the bond in the future. It could have also been used to accurately determine the new bond by taking into account all thing related to the company’s cash flow. d. The YTM would be beneficial because it calculates all subjects pertaining to the bond (any fluctuations or initial cost, ect). Coupon rate uses only face value of the bond and should not be used because it could cause erosion. It also does not consider issuing cost or redemption value.

2.) Using the CAPM model I have computed the cost of common equity using the average beta of Boeing (1.11),...
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