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Investment Appraisal: Matero Corp - Essay Example

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Investment Appraisal: Matero Corp Name: Instructor: Course: Date: Outline 1.0 Introduction 2.0 Net Present Value (NPV) 3.0 Internal Rate of Return (IRR) 4.0 Valuations of Equity 5.0 Consideration for Debt Financing 6.0 Reference Investment Appraisal: Matero Corp Introduction As a small growing construction company, Matero PLC requires a keen observation on the Net Present Value (NPV) and Internal Rate of Return (IIR)…
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Investment Appraisal: Matero Corp

The management will have to evaluate the projects which will generate stable cash flows for Matero PLC for at least 1 year. From the onset, we consider the possible consequences of Matero accepting or rejecting the project of procuring the machinery and plant. For this reason, we emphasise on the determination of the cost of capital whether there will be any form of financial leverage or not. If Matero PLC will decide to use debt financing, there is a hypothesis that the debts will generate higher payoffs for the coming years considering the risk factors that accompanies the borrowed capital. Finally, the management of Matero PLC will have to undertake the valuation of the company, of course, using four separate models for equity valuation. In order to eliminate errors, it will be vital to observe ways in which financial analysts use the models. Net Present Value (NPV) By definition, the NPV is an Investment Appraisal Methods which is the sum of the present values (PV) for all the cash flows that are expected to increase in the event that Matero PLC decides to execute the project. The adjusted capital cost of the firm added to the risk factors of the project determines the rate of discount used in the model in a way that the management will maximize the shareholder equity value (Graham & Harvey, 2001). Ultimately, if the model generates a positive NPV for the project, then the project should be accepted since it will be able to increase the shareholder equity. On the other hand, if the NPV for the project is negative, then it will reduce the shareholder equity, and the project should be rejected. Internal Rate of Return (IRR) The IRR is the cost of capital of the form and the discount rate which equalizes the PV of the cash flows that are expected to increase to the operational cost of the project from the initial stages. After obtaining the IIR for the project, we apply the IRR decision rule which states that if IRR exceeds the rate of return that is required, then the project is accepted, otherwise, we reject the project. IRR measures the profitability of the firm as a percentage of return on every dollar invested in the project. If Matero PLC applies a discount rate of 10%, the NPV is positive the project is acceptable. Again, the IRR exceeds the cost of capital, indicating that the management can approve the project. We consider a situation in which Matero Plc had $500,000 in form of assets with an operating income of $200,000. If the rate of taxation is 40 percent, we look at its impacts on the net income and the Return on equity (ROE) when the EBIT rises or falls by 10 percent. Case 1) with Full Equity financing EBIT - 10% Expected EBIT EBIT + 10% EBIT $180,000 $200,000 $220,000 Interest expense 0 0 0 Income before taxes $180,000 $200,000 $220,000 Tax expense $72,000 $80,000 $88,000 Net Income $108,000 $120,000 $132,000 Shareholders’ equity $200,000 $200,000 $500,000 ROE 54% 60% 26.4% Case 2) Finance: Equity 50% and debt 50% with 5% interest rate EBIT - 10% Expected EBIT EBIT + 10% EBIT $180,000 $200,000 $220,000 Interest expense $20,000 $20,000 $20,000 Income before taxes $160,000 $180,000 $200,000 Tax expense $64,000 $72,000 $80,000 Net Income $96,000 $108,000 $120,000 Shareholders’ equity $400,000 $400,000 $400,000 ROE 24 % 27 % 30 % In the ... Read More
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