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Corporate Finance - Coursework Example

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To: The Director of Capital Investments From: Assistant Director of Capital Investments Subject: Investment Appraisal Date: December 13, 2012 Report Executive Summary A number of capital budgeting techniques were employed to determine whether the replacement of an old crane by a new ALII crane would be beneficial investment for FCL…
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Corporate Finance
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Corporate Finance

However, the application of the IRR technique revealed that the project has an IRR of 20.2% which is less than the rates FCL uses to discount their investments. In consideration of the rate of inflation and the fact that there seem to be no basis for using a 21 per cent and a 26 per cent rate of inflation as suggested in a meeting, the recommendation was made to invest in the project. The basis for this suggestion was that the investment would facilitate an increase in the company’s efficiency. Furthermore, it would help to improve FCL’s image and so allow the company to obtain more contracts and thus increase its revenues. Introduction Investing in a project is not a simple matter. It involves an assessment of different options. If the project relates to an asset for a new idea, this requires consideration of a number of different options which are completely new to the organization. However, if it involves a new piece of equipment to replace an existing one, it requires consideration of the equipment in use compared to the alternative. FCL is considering whether to replace an old crane which has five (5) years left to be put out of commission with a new ALII Crane. The ALII would allow the company to get additional opportunities in the market which the old crane would not be able to facilitate. It would also be able to produce items faster which mean a faster turnaround time and less production backlog for the company. Purchasing a new piece of equipment normally involves a large capital outflow and so the company’s ability to obtain funds is normally one of the main considerations. However, since financing the project is not a challenge, the focus here is not on obtaining money to finance it. Some of the things to be considered include cash flow and the ability of the company to generate enough revenue to make a profit or to break-even with this investment. Additionally, the project needs to be appraised to determine whether the investment will generate the required returns. The project will be assessed in terms of its net present value (NPV) over the ten year period, the payback period and the projects internal rate of return (IRR). Break-even analysis It is important to consider the ability of the company to generate the volume of sales necessary to break-even. The breakeven point is the point at which the company neither makes a profit nor a loss (BPP 2011; Horngren et al. 2000). This is a measure that is frequently used to measure risk in a business (Singh and Deshpande 1982). The ability to generate a profit or to break-even is not the only important issue and so the timing of FCL’s cash flow is also of paramount importance. Cash Flows A projects cash flow is very important. In order to determine the feasibility of the investment the cash flows will have to be evaluated (Emory et al. 2007; Titman et al. 2011). In fact, Popescu (2008) indicates that cash is the lifeblood of a business; therefore, it is important for the people who are placed in authority to pay special attention to cash inflows and outflows and their timing. Cash will flow inwards from sales revenue while cash will flow outwards to pay for expenses that will be incurred on the project. The focus should be on incremental cash flows that are generated from the use of the ... Read More
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