Managerial Finance: Net Present Value Essay

Question:

Discuss about the Managerial Finance for Net Present Value.

Answer:

Calculating IRR, Non-Discounted Payback Period, and Net Present Value of the Projects with Adequate Interpretation:

Particulars

Project B

Project A

NPV

15,715,220.43

28,096,291.64

EAC

$ 4,506,283.73

$ 7,097,013.02

IRR

20.06%

20.39%

Payback period

3.27

3.63

Table 1: Depicting the adequate investment appraisal technique

(Source: as created by the author)

With the help of table 1, overall financial viability of both the projects could be identified. In addition, NPV, IRR and EAC of project A is relevantly higher than project B, which could help Equator to generator higher revenue from operations. However, tenure of both the project is relevantly different and thus use of EAC could effectively help in identifying the adequate project (Vesty and Oliver 2014). Moreover, after the evaluation of the overall investment appraisal techniques Project A is mainly identified as the most viable option, which could help Equator to increase its firm value. Furthermore, both IRR and NPV of the company are mainly higher in project A, which might increase overall return from investment. However, from payback period Project B is mainly identified as the viable approach as it might help in collecting the investment amount faster than project A. Thus, from the overall evaluation of the investment appraisal technique Project A is mainly recognized as the most suitable project, which could allow Equator to generate higher return from investment.

Identifying the Risk Linked Recommended Project:

There are four key risk factor that is been associated with recommended project, which are risk of demand, competition risk, costing risk, and inflation risk. This risk might reduce the overall viability of the project, which could hinder its profitability.

Inflation and Tax Risk Risk:

The overall change in inflation might hamper the cash inflow, which might incur from operations. The decline in inflation and increment in tax rate might reduce the overall profitability from the project, which in turn might nullify the investment appraisal technique.

Competition Risk:

Moreover, the anticipated selling prices used in the calculation could lose its fiction if intense competition is faced by Equator. The product pricing could be reduced for generating the anticipated sales, which in turn might decline its overall revenue. The risk from competition might reduce the overall sales and decline the anticipated cash inflow for each year (Aminbakhsh, Gunduz and Sonmez 2013).

Risk of Demand:

Equator mainly uses anticipated sales units be analysing the customer demand, which could be at risk from changing customer perspective. In addition, Equator is mainly producing computer tablets, whose demand change with customer preference and trust. Moreover, any decline in overall sales unit might reduce ability of Equator to generate the required revenue from investment.

Costing Risk:

The overall anticipated variable, labour, and fixed costs might change, which in turn could reduce the cash inflow anticipated by Equator. The operational cost is mainly kept fixed through the life of the project, which might change due to the impact of inflation rate and change in labour wages. The overall increment in cost might mainly hamper the profitability, which has been anticipated with invest appraisal technique (Halbert and Rouanet 2014).

Providing Relevant Definition of Efficient Capital Market and Determining Impact of on Equator’s Ability to Borrow Funds from the Market:

The overall efficient capital market mainly depicts that share price effectively reflects the information provided by the company. The efficiency of the share price in accommodating information about the company in real time is mainly states as efficient capital market. Moreover, efficient capital market adequately communicates all the relevant data of the company to the investors. Korajczyk (2017) stated that with the help of efficient market hypothesis investors are able to collect the adequate information, which might help in making adequate investment decision.

The overall capital market operating in an efficient manner could help Equator in raising the required capital easily and with low cost. However, there is some limitation of the capital market efficiency, which might in turn increase the overall risk for raising the required fund for the project. There are three type of efficiency market, which might directly reflect on the ability of Equator to borrow the required funds from capital market. The difference forms efficiency market like strong, semi-strong and weak market efficiency could mainly hamper the overall ability to instigate demand of its shares. In addition, if the market efficiency is semi or weak then Equator’s declaration of future prospect will not reflect on its share price. The hindrance of the company to raise overall required capital from the project might hamper its capability to continue with the project. Lee, Tsong and Lee (2014) mentioned that due to the accommodation of advanced technology companies are able to communicate relevant information in the exchange, which is effectively reflected in its share price.

Moreover, if the capital market is not operating in an efficient manner then Equator will not able to deliver the overall information regarding future profits, which could be generated from the project. In addition, extra capital for the new project could be efficiently raised by Equator by issuing new shares. However, if the capital market is not operating in an efficient manner then Equator will not be able to generate the required capital. Moreover, additional cost will be charged and difficulty could be faced by Equator while raising capital from inefficient capital market. Bahmani-Oskooee et al. (2016) mentioned that efficient capital market mainly allows companies for increasing its market presence among potential investors. Lastly, Equator might have a positive impact if capital market is operating in an efficient manner, as it might help the company to reduce the risk arising from its stakeholders. Moreover, with efficient capital market Equator could effectively deliver the required data and reduce the risk from borrowing capital.

Reference and Bibliography:

Aminbakhsh, S., Gunduz, M. and Sonmez, R., 2013. Safety risk assessment using analytic hierarchy process (AHP) during planning and budgeting of construction projects. Journal of safety research, 46, pp.99-105.

Bahmani-Oskooee, M., Chang, T., Chen, T.H. and Tzeng, H.W., 2016. Revisiting the efficient market hypothesis in transition countries using quantile unit root test. Economics Bulletin, 36(4), pp.2171-2182.

Halbert, L. and Rouanet, H., 2014. Filtering risk away: Global finance capital, transcalar territorial networks and the (un) making of city-regions: An analysis of business property development in Bangalore, India. Regional Studies, 48(3), pp.471-484.

Higham, A.P., Fortune, C. and Boothman, J.C., 2016. Sustainability and investment appraisal for housing regeneration projects. Structural Survey, 34(2), pp.150-167.

Johnstone, D., 2015. When are investment projects in the same risk class?. Accounting & Finance.

Korajczyk, R., 2017. How should I invest? What the Efficient Market Hypothesis does and does not say.

Lambe, F., J?risoo, M., Lee, C. and Johnson, O., 2015. Can carbon finance transform household energy markets? A review of cookstove projects and programs in Kenya. Energy Research & Social Science, 5, pp.55-66.

Lee, C.C., Tsong, C.C. and Lee, C.F., 2014. Testing for the efficient market hypothesis in stock prices: International evidence from nonlinear heterogeneous panels. Macroeconomic Dynamics, 18(04), pp.943-958.

Penning-Rowsell, E., Priest, S., Parker, D., Morris, J., Tunstall, S., Viavattene, C., Chatterton, J. and Owen, D., 2014. Flood and coastal erosion risk management: a manual for economic appraisal. Routledge.

Upton, J., Murphy, M., De Boer, I.J.M., Koerkamp, P.G., Berentsen, P.B.M. and Shalloo, L., 2015. Investment appraisal of technology innovations on dairy farm electricity consumption. Journal of dairy science, 98(2), pp.898-909.

Vesty, G. and Oliver, J., 2014. Corporate strategy and accounting for sustainability in investment appraisal. Corporate Ownership and Control, 11(2D), pp.377-388.

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