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### Executive Summary

This report provides analysis for investment decision in Project A and investment choice between Project B and Project C. Method of analysis includes capital budgeting. Weighted average cost of capital is calculated including debt and equity form of financing. Discounting the project A with company’s cost of capital gives positive NPV. But with WACC of project financing NPV of project A is negative. Investment choice between Project B and Project C depends on expected cash flow as both the project has same life and same investment required. Project C has higher expected cash flow than Project B which makes project C as better investment choice. Report includes detailed calculation of WACC, anticipated cash flows, NPV and IRR for project A, B and C.

### Analysis for Project A

#### A. Equity Financing

Theoretically cost of equity is return required by stock holders of company. Formula for calculating cost of equity is

B. Debt Financing

Appropriate cost of debt is 5% for wheel industries. As tax advantage on debt financing brings down the cost of debt, cost of debt after tax will be = 5% * (1-0.35) = 3.25% ### C. Weighted Average Cost of Capital

Firm has decided capital structure consisting of 30% debt and 70% common stock= 0.70 * 11.89 + 0.30 * 0.05 * (1-0.35)

= 9.30%

Use of WACC

WACC is widely used for project evaluation in business

When new project has similar risk profile like existing projects of company, WACC is used to discount such projects to decide between investment options

WACC is used as discount rate to find net present value (NPV) of cash flows.

WACC is used to calculate economic value added (EAV). WACC is cost of capital for project. EAC is calculated deducting cost of capital from profit of the company

WACC is also used for valuation of stock or company. Cash flows are projected for future years and discounted with WACC to find out present value of business, firm or stock.

### D. After tax cash flow

Project A | Year 0 | Year 1 | Year 2 | Year 3 |

Cash inflow | ||||

Additional revenue after tax | $780,000.00 | $780,000.00 | $780,000.00 | |

Depreciation tax advantage | $175,000.00 | $175,000.00 | $175,000.00 | |

Cash outflow | ||||

Initial investment | $1,500,000.00 | |||

Additional annual cost after tax | $390,000.00 | $390,000.00 | $390,000.00 | |

Net cash flow | -$1,500,000.00 | $565,000.00 | $565,000.00 | $565,000.00 |

Initial outlay is $1,500,000 (Investment)

Additional revenue after tax for 3 years is $1,200,000 * (1-0.35) = $780,000

Initial investment is depreciable on straight line method for 3 years

Depreciation each year = $1,500,000/3 = $500,000

Tax advantage on depreciation = $500,000 * 0.35 = $175,000

Additional annual cost after tax for 3 years is $600,000 * (1-0.35) = $390,000

Net cash flow for year 1, year 2 and year 3 is $565,000

### E. NPV

Discount rate is 6% Project A | Year 0 | Year 1 | Year 2 | Year 3 |

Net cash flow | -$1,500,000.00 | $565,000.00 | $565,000.00 | $565,000.00 |

Discount factor | 1 | 0.94339623 | 0.88999644 | 0.83961928 |

Discounted Cash Flow | -$1,500,000.00 | $533,018.87 | $502,847.99 | $474,384.89 |

NPV | $10,251.75 |

Discount factor = 1/(1 + 6%)^Year

Discounting cash flows with 6 % gives NPV of $10,251.75

As NPV is positive it’s financially feasible to undertake the project

Positive NPV shows project is generating $10,251.75 cash in present value after covering cost of capital

### F. IRR

IRR for project is 6.37%### Analysis for Project B and Project C

#### A. Cash flows

Project B | Probability | Cash Flow | Expected Cash flow |

0.25 | $20,000.00 | $5,000.00 | |

0.50 | $32,000.00 | $16,000.00 | |

0.25 | $40,000.00 | $10,000.00 | |

Expected Annual Cash flow from Project B | $31,000.00 |

Project C | Probability | Cash Flow | Expected Cash flow |

0.30 | $22,000.00 | $6,600.00 | |

0.50 | $40,000.00 | $20,000.00 | |

0.20 | $50,000.00 | $10,000.00 | |

Expected Annual Cash flow from Project C | $36,600.00 |

For project B, expected value of cash flow considering probabilities of different cash flows is $31,000

For project C, expected value of cash flow considering probabilities of different cash flows is $36,600

Project B | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 |

Net cash flow | -$120,000.00 | $31,000.00 | $31,000.00 | $31,000.00 | $31,000.00 | $31,000.00 | $31,000.00 |

Discount factor | 1 | 0.925925926 | 0.85733882 | 0.7938322 | 0.7350299 | 0.6805832 | 0.6301696 |

Discounted Cash Flow | -$120,000.00 | $28,703.70 | $26,577.50 | $24,608.80 | $22,785.93 | $21,098.08 | $19,535.26 |

NPV | $23,309.27 | ||||||

IRR | 14.17% |

Project C | Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 |

Net cash flow | -$120,000.00 | $36,600.00 | $36,600.00 | $36,600.00 | $36,600.00 | $36,600.00 | $36,600.00 |

Discount factor | 1 | 0.925925926 | 0.85733882 | 0.7938322 | 0.7350299 | 0.6805832 | 0.6301696 |

Discounted Cash Flow | -$120,000.00 | $33,888.89 | $31,378.60 | $29,054.26 | $26,902.09 | $24,909.35 | $23,064.21 |

NPV | $49,197.40 | ||||||

IRR | 20.57% |

### B. Conflict between IRR and NPVs

Conflict between IRR and NPV occurs when project size is different and project life is different### C. Investment Decision

Discounting cash flow with 8% project B gives NPV of $23,309 and Project C gives NPV of $49,197### Recommendation

Wheel industries need to raise capital for financing of project A. Current cost of capital is 6% for ongoing projects. WACC for project A is 9.30%. Discounting project A with existing cost of capital gives positive NPV while discounting project A with WACC of financing it gives negative NPV. WACC of financing for Project A would be correct discount rate than using existing cost of capital of company. As with WACC of 9.30%, NPV is negative it’s not recommended to invest in Project A

Project B and Project C both have same investment and life. But expected annual cash flow of project C is higher than Project B. Discount rate for both the project is same which makes NPV of project C higher than Project B. It’s recommended to invest in Project C between project B and Project C.