Investment Appraisal of Embraer Company - Essay Example

INVESTMENT APPRAISAL This part of the report will analyse how the company, Embraer would be able to perform in the years to come and whether the company is a good option for investment purpose or not. This part of the report will use the forecasted financial statements of the company for the years 2013 to 2017 (attached in the appendix). The financials from the forecasted financial statements would be used to evaluate how profitable the company would be. Financial statements of company have been forecasted using the data of the company since 2007, as it has been said that the historical data can be a good indicator of the future performances so same concept has been used to forecast the financials of Embraer. Different investment appraisal techniques would be applied on the forecasted financial statements of the company and then the company would be evaluated for the purpose of investment. Some of the investment appraisal techniques that have been used to analyse the company’s performance are: Net present value of the future cash flows, internal rate of return, Benefit to cost ratio, Profitability Index, and average accounting rate of return. These techniques have been used to analyse whether the company is a good option to invest or not. Net Present Value of the Future Cash Flows Forecasted financials of the company have been used to identify the future cash flows of the company. The expected net income of Embraer for the coming years has been shown in the table below: Year 2013 2014 2015 2016 2017 Net Income (e) $ in millions 347 376 408 442 479 The expected net income has been discounted with the estimated growth of the company. Expected growth has been calculated from the growth the company achieved from its sales of last complete year i.e. sales of year 2010 and sales of year 2011 have been used to calculate the estimated growth. It has been found from the financials of the company that the company has been making an investment every year. The investment made by the company has been varying since 2007 and therefore average of the investment of the company has been taken and the same amount or the average amount has been assumed to occur in the years to come. The average investment made by the company is found to be $376.33 million (Embraer d, 2012). After discounting these figures, the present value of expected net income has been: Present value of future cash inflows $1,601.33 Present value of future cash outflows ($1,488.21) Net Present Value $113.12 As the net present value of the future cash flows is positive therefore according to the NPV, one should invest in the company. However, NPV is not very high but even positive NPV investment opportunity is worth investing as it would have a higher return in future. Internal rate of return Internal rate of return is rate of return where the future value of the cash flows is equal to 0. Internal rate of return of future cash flows is 82.37% and this is the rate where the future cash flows after being discounted are showing an NPV of 0 (Gitman, 2003). As the value of IRR is 82.37% which is more than the growth rate of the company or the hurdle rate therefore the project should be accepted and investment should be made in the company. Benefit to Cost Ratio (BCR) Benefit to Cost ratio is one of the accounting techniques that has been used to analyse whether one should invest in the project or not. According to this technique, the benefits or profits from the company or project are compared with the cost associated. If the benefits are greater than the cost then the investment should be made and if the cost is higher than the benefits then investment should not be made (Gaffikin, 2008). The costs and returns for the company have been shown in the table below: Year 2013 2014 2015 2016 2017 Total Returns 347 376 408 442 479 2,051 Investment / Cost 376.33 376.33 376.33 376.33 376.33 1,882 After comparing the cost and benefit ratio of the future earnings of the company, it has been found that the benefits are more than the cost. In the next five years, the company would be able to have a net benefit of $169 million. The BCR Ratio therefore is calculated below: BCR can be calculated using the above formula: As the value of BCR is more than 1, therefore the investment should be made in the company. Profitability Index The other technique that has been used to analyse the performance of the company is the profitability index. The formula for calculating profitability index is as follows: Here the investment made since 2007 has been considered as the initial investment. Profitability index of Embraer is calculated to be 0.709. As the value of the profitability index is below 1 therefore according to profitability index one should not invest in the company. Accounting rate of return Accounting rate of return is another technique that is used by the accountants and management to analyse whether to invest in the project or not. Accounting rate of return shows the average return that the company earns on the average investment it made (Drury, 2008). The average investment as discussed earlier is assumed to be constant at $376.33 million. This is calculated using the past investment the company made since 2007. The average expected return of the company is as follows; Year 2013 2014 2015 2016 2017 Average Returns 347 376 408 442 479 410 Accounting rate of return can be calculated using the following formula: So, using the above values rate of return can be: The accounting rate of return is found to be 109% which is high. The average rate of return of the company since 2007 is found to be 90% and therefore the expected average rate of returns are higher than the previous average return therefore one should invest in the company. QUALITY OF ASSUMPTIONS AND ANALYSIS Assumptions In order to forecast the financial statements of the company in the years to come, following assumptions have been made. a. Embraer has released the financial statements for the third quarter of the year 2012. It has been assumed that the figure reported during the three quarters of the year would grow in the same way and therefore all the figures have been multiplied by 1.3333 to get the figure for the complete year for 2012. b. In order to forecast the financial statements for the coming years i.e. from 2013 to 2017, the ratio of cost of goods sold and sales have been identified from the past three years and the same ratio has been applied to calculate the cost of goods sold. c. Last year growth in sales of the company has been taken in order to forecast the increase in revenues of the company in the years to come. The growth in the year 2012 is not taken to forecast the sales of the coming years because the sales of 2012 have already been assumed to grow at the same rate. d. All the expenses and costs have been assumed to be growing with the same ratio to sales as they have been since 2007. Therefore the ratio for different financial figures has been identified and then during estimation, the same ratio has been applied to forecast the figures. e. Since 2007, investment made by the company has been fluctuating every year, therefore average investment made by the company since 2007 has been taken and it has been assumed that the investment would be made according to the average since 2007. Analysis Different investment appraisal techniques have been applied to analyse whether investment should be made or not in the company. It has been found that most of the investment appraisal techniques are in favour of investing in Embraer. However, Market to book value ratio is also used to analyse whether investment should be made in the company or not: Market to Book Value Market to book value is a ratio that is used to compare the book value of the company with the market value. Book value shows the accounting value or the historical value of the company whereas market value shows the current market worth of the stock of the company (Market/Book Ratio). Formula to calculate this ratio is as follows: To analyse market to book value ratio; Embraer has been compared with its competitor Boeing. First of all, market to book value of Embraer will be calculated. In order to calculate the book value per share of the Embraer, following formula will be used: Book value per share of Embrear is found to be $8.081. The market value of the company is $27.76 so these values will be used to calculate the market to book value and it is found to be 3.435 Now, the market to book value of Boeing will be calculated. So, first of all the book value of Boeing needs to be calculated and it is equal to 28.35. The market price of the company is 71.11 so these values will be used to calculate the market to book value ratio and it is 2.51. If the value of this ratio is less than 1, then it means that the stock is overvalued however as the ratio of both the companies is higher than 1 therefore it means that the stock is undervalued. The higher the stock being undervalued, there are more chances that the stock would increase its price. So, according to market to book value ratio, one should invest in Embraer. List of References Boeing. (2011). Annual Report. Available at http://www.envisionreports.com/BA/2012/14427FE12E/5aeaf07f40c94540856bcbf8d53d7e39/Boeing_AR_3-9-12_SECURED_2-reduced.pdf [Accessed 29 October, 2012] Drury, C. (2008). Management and Cost Accounting. 7th edn. Cengage Learning EMEA Embraer a. (2012). Net Income. Available at http://ri.embraer.com.br/show.aspx?idCanal=vU+xBDApZfmPYf25l1NUSw%3d%3d [Accessed 26 October, 2012] Embraer b. (2012). Net Sales. Available at http://ri.embraer.com.br/show.aspx?idCanal=gtQgE0baKIA1ffmlMu1BuA%3d%3d [Accessed 26 October, 2012] Embraer c. (2012). Income from Operations. Available at http://ri.embraer.com.br/show.aspx?idCanal=MV3nU8PanJBtLn3TJaDFTg%3d%3d [Accessed 26 October, 2012] Embraer d. (2012). Investment. Available at http://ri.embraer.com.br/show.aspx?idCanal=ZEnqHFQ1IBuqQFOagIZ5JA%3d%3d [Accessed 26 October, 2012] Embraer. (2011). Annual Report. Available at http://www.embraer.com/Documents/Relatorio_Anual_2011_Ing.pdf [Accessed 29 October, 2012] Gaffikin, M. (2008). Accounting Theory: Research, Regulation and Accounting Practice. Boston: Pearson Education Gitman, L. (2003). Principles of Managerial Finance. Boston: Addison-Wesley Publishing. Market/Book Ratio. Qfinance. Available at http://www.qfinance.com/contentFiles/QF01/g87ba2m9/10/1/market-book-ratio.pdf [Accessed 29 October, 2012] Appendix Read More