Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

De La Salle University-Manila
Ramon V
...
Julius Buendia

Submitted on:
May 15, 2021

I
...
Although Parker admits that he has had
negative encounters with MBAs, he views Jones differently because of her sensitivity to
real-world complexities as well as her impressive communication and people skills
...

The plywood division is an integral part of the company's operations, with nearly two entire
plants dedicated to the production of plywood panels
...
They have two options for models: Nakoi (made in Japan) and
Dakota (made in America)
...
Dakota is nearly double the price of Nakoi, but it has three advantages
...

Parker's capital budgeting practices are known as fixed asset purchasing guidelines
(FAPG)
...
For relatively small investments, the company relies solely on the
payback method, at least two-year payback and three-year tops
...
The payback is still used, in part
because Parker uses it as a risk measure, and in part because it is easy to calculate
...
He also acknowledges that he dislikes seeing a project's
payback period exceed five years
...
He
constantly reminds them that forecasters must be truthful seekers of truth if the business is
to be the best it can be
...

According to Jones, the main disadvantage is the lack of any discounted cash flow strategy
...
Parker also seems to be able
to consider capital budgeting based on market returns
...


II
...


III
...


Statement of Objectives
● Determine which among the two choices would be a better investment for
additional plywood press to increase production capacity and to be able to make a
sound recommendation on which project to choose
...


V
...
Facts of the Case
● The relevant tax rate is 40%
...

● Parker defines a “small investment” as a project less than $10,000 and maybe as
much as $15,000
...

● Parker monitors the company’s forecasting efforts in two ways
...
Second,
from time to time he hired outside consultants to compare the actual cash flows of
a project with those predicted
...

● Parker recognizes that 20% target return is a book value and not a market rate
...

● Dakota is nearly double the price of Nakoi, but it has three advantages
...

B
...

● The company can consider an investment with a longer payback period as long it
is justified by the higher return on investments
...


C
...
It is a measure of a
company’s short-term liquidity and is important for performing financial analysis,
financial modeling, and managing cash flow
...
d)
Working Capital = Current Assets – Current Liabilities



Capital Budgeting - refers to the decision-making process that companies follow
with regard to which capital-intensive projects they should pursue
...
d)



Fixed Asset - refers to long-term tangible assets that are used in the operations of a
business
...
d)



Payback Period - shows how long it takes for a business to recoup an investment
...
d)
Payback period = Cost of investment / net cash inflows



Average Accounting Rate of Return (AARR) - determined by dividing the project's
average annual net income by its average book value
...
The ARR is a formula used to make capital budgeting decisions
...
) based on the future net earnings expected
compared to the capital cost
...
d)
ARR = Average Annual Profit / Average Investment



Internal Rate of Return - the discount rate that makes the net present value (NPV)
of a project zero
...
(CFI, n
...
(CFI, n
...
The index is a useful tool for ranking investment
projects and showing the value created per unit of investment
...
d)

D
...
This involves providing a quantitative view,
particularly looking into the costs and benefits of each project that serve as a basis for
making management decisions
...
There are six stages
in capital budgeting:
1
...
Usually, there are multiple alternatives for each initiative
...
Search Stage – The management will start to look into each alternative capital
investment and determine if these are necessary to achieve the objectives and
strategies of the company
...
Information-Acquisition Stage – The third stage entails estimating the costs and
benefits, including the risks involved in each capital investment
...

4
...

5
...

6
...
During this stage, the
management should be able monitor and track the progress in terms of costs, cash
flows involved and benefits derived from the project
...
SWOT Analysis
Strengths
● Good company reputation and
strong branding
● Quality product
● Conservative forecasting
● Focused on the lumber industry
● Open to purchasing of equipment
that would boost the company’s
production capacity
Opportunities
● Company expansion to other areas
of the state
...


Weaknesses
● Operation heavily relies in outdated
equipment
● Limited number of production
capacity
● Offers small array of products
● Exclusively depends on the
payback method with no specific
guidelines
Threats
● Machineries modernization in the
industry
● Increasing number of competitors

Questions and Solutions
1
...
Calculate the Dakota's Payback period, AARR, IRR, NPV and Profitability
Index:

NOTE: The table below shows these figures for the Nakoi
...
Payback period
Payback period = Cost of investment / net cash inflows
Payback period = 1,300,000
...
71
Payback period = 3
...
Average accounting rate of return (AARR)

c
...
NPV

e
...
Rank the plywood presses by the five techniques listed in question 2
Payback Period
Dakota has a payback period of 3
...
8
years
...
45 years, or approximately 6 months
...
91 percent, while Nakoi's is 42
...
In terms of AARR, this means that Nakoi is the better choice
...
27 percent compared to 30
...
This means that, once
again, Nakoi is the better choice in terms of IRR
...
In terms of NPV, Dakota is a
wiser option than Nakoi
...
39, while Nakoi received a score of 1
...

In terms of PI, Nakoi is a better alternative than Dakota
...
Do the techniques rank the projects the same? If not, why do the rankings differ?
The techniques ranked the projects distinctively
...
Payback
period, for example, differs from Net Present Value because payback period is used to
calculate how long it will take to repay the investment compared to the overall value
of the project in terms of the present time
...
For example, both IRR and AARR
demonstrate the percent return on a specific project, but they do so from different
perspectives
...
However, AARR does not account for the time
value of money
...


5
...

a
...
It is the period where the company will meet its break-even
point before gaining profit from its acquired assets
...

One of the disadvantages of payback compared to other capital budgeting methods
is its tendency to disregard the time value of money
...


Advantage of this method would be its application
...
This method is also applicable in projects with high degree
of uncertainty as the time duration can identify the level of liquidity and risk associated
with the projects
...
What are the disadvantages of the AARR? What, if any, are its advantages?
ARR reflects the expected percentage of return on an investment after its initial
investment cost
...
Like payback, ARR does not
consider the cash flow nor time value of money which is crucial in managing a business
...
This method is also affected by non-cash items such as
the rate of depreciation in calculating the profits
...

However, like the payback period, ARR is also easy to understand and apply
...
Moreso, another advantage of ARR is it recognizes the earnings after tax and
depreciation which is the concept of net earnings
...
Jones intends to discuss with Parker the net present value and internal rate of
return methods
...

a
...

The Internal Rate of Return (IRR) is the annual rate of growth an investment is
expected to generate
...

b
...
An
investment/project with a negative NPV will result in a net loss
...

Generally, the higher the internal rate of return, the more desirable an investment
is worth undertaking
...
If the IRR on a project or

investment is lower than the cost of capital, then the best course of action may be to
reject it
...
What are the advantages of NPV? What, if any, are its disadvantages?
NPV provides an unambiguous indication based on the wealth created by a
potential investment
...
It also accounts for the time value of money, something other
methods do not utilize
...

Estimated factors include investment costs, discount rate, and projected returns
...
Discount rates, like interest rates, can and do change year-to-year
...
What are the advantages of the IRR? What, if any, are its disadvantages?
IRR also considers the time value of money when evaluating a project
...
In IRR, there is no requirement for finding out the IRR
hurdle rate or the required rate of return
...

The IRR is very useful in comparing projects with different lifespans or amount of
required capital
...

e
...

Although NPV and IRR are closely related concepts, the IRR of an investment is
the discount rate that would cause an investment to have a zero value for NPV
...
NPV tries to answer
what the total amount of money will the company be making if it proceeds with the
investment, after taking into account the time value of money
...

7
...
This accounting tool identifies the ratio of pay off
to investment of the proposed projects as it quantifies the value created per unit of

investments
...

However, the down side of the Profitability Index would be its calculation process
...
Also, considering that interest rate and discount rate is difficult to
understand as estimation instead of facts are being used in generating information with
PI calculations
...
Parker apparently spends much time and effort trying to obtain accurate cash
flow forecasts
...

Yes
...
Therefore, it is inherent
for Parker’s to scrutinize the accuracy of forecasting as the method depends on the
future cash flows which will negatively impact the effectiveness of a firm’s decision
making once the estimates are deficient or atop
...
Any capital budgeting decision involves estimating future cash flows
...
That is, we want
forecasts that are just likely to be as below the actual cash flow
...

a
...
” Are you surprised by the result of the postaudit?
Explain
We are not surprised by the result
...
He usually asked the specific reasons for such a
cause
...

b
...
e
...
What difficulties if any,
would this create?
It’s critically important to maintain an accurate cash flow forecast and cash flow
statement
...
This may result in loss
of opportunities in projecting sales
...


10
...
What do you like about Parker’s capital budgeting procedures and why?
Parker’s alignment of capital budgeting procedures to the company’s mission and
industry focus is a practical and efficient approach to avoid wasting time and resources
...
Using complex
approaches and exerting effort on projects that are low-risk and provide less impact to
the company can be time-consuming and a waste of resources
...

b
...
These metrics have flaws as they fail to consider the time value of
money, therefore missing out the future cash flows in the equation
...
While we like
Parker’s use of various techniques as investment considerations, it is important for such
methods to be reliable and appropriate
...

11
...

The existing capital budgeting procedure for evaluation on whether to accept or
reject small projects should be maintained, as it remains to be appropriate and saves
the company time and resources
...
We believe that looking into
AARR and payback methods are ineffective and that the company should use NPV and
IRR instead to ensure that the time value of money is considered
...

12
...

Based on the results of the computations, Nakoi leads in terms of Payback period,
IRR, AARR and Profitability Index
...
To choose the best alternative, we take into account the advantages
and disadvantages of these methods, as answered in the preceding guide questions
...
All other metrics fail to account the overall
picture, and thus, Dakota should be the best option
...


Alternative Courses of Action

ACA 1: Maintain the status quo and reject two investment options
Pros

Cons

● The company will save funds in a short
run
...
The inability
to do so might result to the company
being unable to expand its production
capacity as they intend to, thus hurdling
long-term growth plans

● No changes in the production process
and there will be no training expenses
as manpower are already familiar with
the features of existing machineries
...

● The company will have to allot funding
on labor as its old machinery requires a
high manpower requirement
...


ACA2: Franklin Lumber to purchase Nakoi instead of Dakota
Pros

Cons

● Offers shorter payback period, thus,
there is an immediate recovery of
investment and is considered to be less
risky investment than Dakota

● Can produce a lower level of output
than Dakota’s and may be susceptible
to inefficiencies

● Entails lower costs involved in the
purchase of this machine

● It has lower NPV which entails lower
contribution to shareholder’s wealth
...


ACA3: Franklin Lumber to purchase Dakota instead of Nakoi
Pros

Cons

● Provides superior NPV, contributes to
maximizing shareholder value

● Has a longer payback period

● Allows the company to produce a
higher level of output

● Higher costs in the purchase of the
machine

● Easier to operate and can retain its
value better because of its modern
system
● Dakota requires a low manpower
requirement due to its exemplary and
modern features
...


Decision Criteria and Evaluation of Alternative Courses of Action
A
...


30%

To approve the alternative
which provides for the most
favorable outcomes, in
account of cash flows (NPV)
that can maximize
shareholder value and support
profitability for the company
in the long-run
...


25%

To choose the project that
delivers the anticipated
returns to cover the costs
involved at the shortest time
as possible
...
This also
includes a proposal involving

a payback period that is
justified with the returns
...

Production Efficiency

The measure for the
machine/equipment’s
production output and uses the
least resources as possible

20%

To seek the most viable
option that ensures that
production is optimized and is
able to meet the required
output at a period of time

B
...

In sustainability criteria and Return on Investment, Dakota got the highest score
considering its capability to produce a higher level of output which can positively affect
the increase of company’s profitability and ROI
...

For the risk, Nakoi got the top spot given that Dakota is state-of-the-art and requires
higher maintenance
...
This could also make the profit
dependent on the stability of the machine
...
It can also sell extra output, contains lower labor cost and is easy to operate
...


Recommendation
After utilizing different evaluation methods, the researchers deem that Franklin
Lumber purchased Dakota instead of Nakoi as a wiser decision
...
The researchers weigh greatly the fact that Dakota has far superior Net Present
Value (NPV) where it considers both revenue and cost
...
It is also notable that
Dakota has greater contribution to production level, lowers labor cost due to its operation,
and holds greater value on its 7-year after-tax market value compared to Nakoi
...


X
...
(2021, March 25)
...
Corporate Finance Institute
...
com
Horngren, C
...
, Datar, S
...
& Rajan, M
...
(2015)
...

Pearson
Net Present Value (NPV)
...
d
...

https://www
...
com/terms/n/npv
...
(n
...
Investopedia
...
investopedia
...
asp
https://corporatefinanceinstitute

---