Company Culture and Making the Investment Decisions - Assignment Example

Company Culture and Making the Investment Decisions Question 1 There are various qualitative factors taken into consideration while making the investment decisions. Company Culture The organization culture is one of the factors taken into consideration while making capital investment decision. Before making any investment decision, it should be taken into consideration that how would the resources affect the culture of the organization. Let us take for an example- if the business is planning for expansion then it should take into consideration the impact of the cultural differences in the communication or information flow at all levels of management. It may also affect the performance within the organization. However cultural considerations are taken into account more in case of productive physical resources rather than financial investments. Product/Service Quality This is an essential factor to be taken into consideration while making any investment decision. The quality of the invested capital resources has a direct effect on the quality of the products or services of the organization. The least extensive investment resources would be yielding the lowest quality of products or services for the organization. The manager requires balancing between the quality and the cost for maximizing the cost efficiency of the investment. In a similar manner let us consider another example- purchase of the lowest quality of vehicle for the on-site workers would result in the interruptions in fluent or efficient services due to vehicle breakdowns or other related problems. If Laurentian Bakeries Inc. purchases lower quality equipments, it would result in the preparation of low quality food products. Thus the company requires finding a balance between the cost and the quality in order to increase the efficiency of the investment. Environmental Concerns The capital investment also possesses impact on the environment. The higher financially appealing option has higher impact on the environment as compared to the costlier options. It is due to this reason that the quantity factor of price directly impacts the qualitative factor associated with environmental responsibility. It is very important for the manager of Laurentian Bakeries Inc. to consider the impact that the capital investment decision possess in the environment (Albrecht, 2011). Implementation of strategic plans The strategic plans for the first year of the project are identified to be the operating plan for the same. The operating plan is supported by a detailed list of capital projects which are proposed earlier and thus, becomes the basis for the capital allocation of the project. Initiatives are taken to improve the strategic plans and the benefits associated with the company (Jennings, 2006). The managers are also trained in such a way that they can give out proper instructions to their employees and thus, balance the operation efficiently (Porter, 2011). The corporate strategies are also evaluated in order to acquire the successful projects. The companies are evaluated with regard to the challenges that are being faced by them. The tangible actions have to be linked with the corporate vision so that the projects are successful and yield suitable results. The risk minimising factors are also evaluated in order to take the right decision for any project. The quantitative factors that are required for the evaluation of the projects of the company are as follows: 1) Net Present Value: Net present value is the difference in between the present value of the total cash inflow and the present value of the total cash outflow. It helps in determining the value of an investment project thereby facilitating the investment decisions. It is calculated as: NPV= [C1/ (1=r) + C2/ (1+r) ²+ C3/ (1+r) ³+..............+Cn/ (1+r) ̂n] – Co Where C1, C2.....Cn are the values of cash inflows from the first year to n number of years and Co is the value of cash outflow. Generally, if NPV > 0, then the project will add up to the firm’s value. Thus, the project should be accepted. In other circumstances, it is rejected. 2) Internal Rate of Return (IRR): It is the measure to compare the profitability of the projects. It is actually the rate of return at which a company makes the NPV of all the cash flows to be zero for a particular project. It can be also referred as the discount rates that make the present value of the future cash flows equivalent to the initial outlay. The projects with higher IRR are desirable to undertake. A project is accepted only when the IRR is greater than the minimum acceptable cost of capital or rate of return. Question 2 Calculation of the free cash flows of the project Free cash flow (FCF) can be defined as the method of evaluating the cash flow of the business to derive the obtained from the distribution among the holders of the securities of a corporate entity. The method is very useful for evaluating the success of projects. Calculation of Cash Flow of the project     $ in million Building in Winnipeg 1.3 Spiral freezer 1.6 High Speed pizza processing line 1.3 Warehouse space 0.6 Contingency needs 0.4 Net cash flow 5.2 Calculation of Working Capital Year 1993 1994 1995 Current Asset 24 29.3 35.7 Current Liabilities 8.2 9.2 10.5 Working Capital 15.8 20.1 25.2 The figures in the above table indicate the fact that the project has adequate working capital, thereby indicating an adequate current asset to finance the current liabilities, so that the inventories are not harmed. Working Capital Ratio 2.926829268 3.184782609 3.4 From the above table, it is clear that the working capital ratio has been increasing over the years and therefore, the project will have adequate current asset to finance the current liability. Change in working capital 0 0.25795334 0.215217391 The working capital has increased by 21% over the years from 1993 to 1995. Question 3 Calculation of the discount rate of the project Here the discount rate indicates the weighted average cost of capital. It will include the cost of debt of the company which is calculated by summing up the risk free rate and the spread that exists between the return on the BBB rated bonds and the risk free rates. Bond rates Risk free rate Risk free rates - bond rates 1 Year 7.37 6 -1.37 5 Year 7.66 10 2.34 10 Year 8.06 12 3.94 20 Year 8.3 14 5.7 30 Year 8.35 16 7.65 Discount rate 18.26 Hence the discount rate is calculated to be 18.26%. Question 4 Calculation of NPV and IRR NPV can be defined as the difference between present value of the cash inflows and present value of the cash outflows. It is studied to get the profitability of a certain investment. Calculation of NPV NPV can be calculated by using the following formulae: NPV = [R * {1-(1 + i) – n } / i ] where, R = net cash inflow i = required rate of return for the period =18% n = number of years the project is expected to take Here, The Net cash inflow will be the net income that is incurred by the company. It is given in the income statement of the company. Calculation of NPV 1993 ($ millions) 1994 ($ millions) 1995 ($ millions) Net Cash inflow (Net income) 8.6 8.2 8.4 Rate of Return 0.18 0.18 0.18 NPV 38.64914214 36.85150762 37.75032488 From the above figure of NPV, it can be inferred that the company has a positive and increasing Net present value, which indicates that the company can accept the project of expansion. Calculation of IRR The internal rate of return of an investment can be defined as the “annualized effective compounded return rate" or "rate of return" (Henry and Piekarski, 2005) which makes The NPV of the project equal to zero. Calculation of IRR 1993 ($ millions) 1994 ($ millions) 1995 ( $ millions) Cash flow 8.6 8.2 8.4 1/(1+r)^n 1.18 0.308641975 0.171467764 Total Cash Flow 25.2 Initial investment 5.2 Therefore, Total cash inflow/ (1+r) 10 – Initial investment = 0 Here, r = Internal rate of return Or , 25/ (1+r)10 – 5.2 = 0 or, 25/ (1+r)10 = 5.2 or, 1/ (1+r)10 = 5.2/ 25 or, 1/ 0.208 = (1+r)10 or, 4.8 = (1+r)10 or, log10 4.8 = 10 log10 (1+r) or, 0.68 = 10 log10 1 + log10 r or, 0.68 = 10 *0 + log10 r or, 0.68 = log10 r or, antilog 0.68 = r or, r = 5.97 or, r = 6% Hence the internal rate of return is 6%. Question 5 Sensitivity analysis in finance studies the uncertainty of various factors of the business. It actually measures the effect of increase or decrease of the unknown factors on NPV. For example, if the unknown factors are increased by 20%, then a sensitivity analysis is done to study the effect of the change on NPV. The factors are sales, profit and output (Warren, 2009) In this case study, if the net income of the project is increased by 20%, then it will have direct effect on the NPV of the project. NPV of the projects are as follows: NPV 38.64914214 36.85150762 37.75032488 If the net income is increased by 20% then the Net income are as follows: ($ millions) Net Cash inflow (Net income) 8.6 8.2 8.4 20% increase 10.32 9.84 10.04 Rate of Return 0.18 0.18 0.18 NPV 38.614 36.818 37.716 From the above table, it can be inferred that with 20% increase in net income, there is a decrease in value of NPV. The NPV has decreased by (38.74-37.716)/38.61= 2%. Question 6 After considering the qualitative and the quantitative factors of the project it can be concluded that the project is acceptable. The reason behind the acceptance is elaborated below: 1) Laurentian had been manufacturing frozen pizzas at Toronto plants until 1992, but after that it has become the sole supplier of the private frozen pizzas for large grocery chains. It has further concentrated on expanding its manufacturing business in Winnipeg successfully. They have made a strategic plan for the project and its expansion, which clearly indicates the operations of the plant in Winnipeg. 2) They have made an analysis about the probable profitable sale of frozen pizzas in Winnipeg or otherwise. They have also expected the plant sales capacity to be 10.9 million since they have surveyed that the opportunity for the sale of pizza is quite high in Canada. 3) They have even made plans to supply frozen pizzas to large U.S. based groceries which will accelerate their sales rapidly. They have expected that the groceries in U.S. will provide them 50% of the total orders of pizza. They have planned to sell frozen foods to their customers at $1.70 and have also expected that the price will rise due to the inflation. 4) The main expenditure that is required by the expansion projects is of expanding the existing buildings, spiral freezer, new high speed pizza processing line and warehouse space. There will be no additional requirement of land for building plants. The management team has also suggested that there is no need for additional requirement of the administrative staffs. It is also realised by the management that the working capital would increase the additional sales of the project. Now, with the increased sales, the project will encounter reduction in production cost by $0.019 and the 70% of the efficiency that has been increased, will be realised in the first year of its operation. 5) The Net Present Value of the projects reflects that the company can accept the project as it is seems to be positive. 6) However, the Internal Rate of Return is lower than the rate of return which implies that the projects will incur lesser return than expected. Thus, it can be concluded that the company can accept the expansion project at Winnipeg. However, the factors that have already been discussed earlier must be taken into consideration by while making the investment decision. The investment must not include such lower investment amount that it ultimately results in the decrease in the performance of the organization due to low quality products and services. As the organization is planning for a business expansion plan, it must focus on the fact that it successfully aligns the cultural values of the organization with the cultural values of the place where it is planning to start the operations. This would enable efficient communication or information flow at all levels of management thereby increasing the efficacy level of the organization. The managers must also take into account the fact that they find a balance between the quality and the cost so that the loyal customers do not have to compromise with lower quality products because of the low investment. Moreover, the impact that the capital investment decisions possess on the environment should also be taken into account. It must be considered that the investment decision does not have any negative impact on the environment. The investment decision, when considered from the perspective of quantitative factors, is effective as it would be providing positive NPV for the organization. Reference list Albrecht, W., 2011. Financial Accounting. New York: South-Western Cengage Learning. Henry, C. and Piekarski, J., 2005. Techniques for Capital Expenditure Analysis. New York: M Dekker. Jennings, R., 2006. Financial Accounting. Singapore: British Library Cataloguing-in- Publication Data. Porter, G., 2011. Financial Accounting. New York: South-Western Cengage Learning. Warren , C., 2009. Financial Accounting. New York: South-Western Cengage Learning. Read More