[Author Name]
There are basically two parts of this assignment that needed to be complete and both of the parts related to Capital budgeting. There are two different investment alternatives have been given to analyze which one would bring synergy based effects for the company.
Part-1
Data is as under of both of the investment alternatives
Net Present Value
NPV should be greater than that of the initial outlay. Though, both of the projects are in positive term but both the projects are mutually exclusive. According to Block, Hirt, a company should go with the project which has a higher NPV as compared to other project (Block, Hirt, 2012). Therefore, the company should go with Alternative A, as it would certainly bring positive economic and synergy based effects for the company because of higher NPV.
2. The NPV of Alternatives A and B after three years is -9610.83 and -62437.75 respectively. As the NPV for Alternative A is higher than NPV of Alternative B, hence Alternative B should be adopted. We can also choose a different approach and consider only the cost of the alternatives rather than calculating the NPV. The Cost saved by alternatives one and two during the first three years adds up to 228000 and 337000 respectively. If we subtract the cost saved from the initial investment, this would be 43000 and 17000 for alternatives A and B respectively. This shows that the cost saved by Alternative A is significantly more than Alternative B. Hence taking the cost into account, the Alternative A should be adopted.
3. The table below shows the NPV of both alternatives at end of year 4 and 5. Based on these calculations we can see that at the end of year 4 the Alternative A has a positive NPV so the alternative has proven its worth. At the end of year 5, the salvage value would be nil so the company should remove the equipment after 4 years to get the salvage value of $35000. Hence at this stage the company may remove the equipment and claim the salvage value.
Part-2
Sensitivity analysis would be performed on two different cost of capital, which are 14% and 16% and the computation of the same is mentioned below
@ 14%
@ 16%
After the sensitivity Analysis, Project A is still on the 1st rank because of its higher NPV
2. Considering the risk factor for both the alternatives it can be concluded that they would not bring about any significant change in the economic situation of the company, however alternative A has a higher NPV which makes it worth the risk. In both the scenarios, with the discount rate of 14% and 16%, the NPV of Alternative B remains significantly lower than that of Alternative A even though the discounted cash flow of Alternative B is higher than Alternative A. This shows that the costs saved by Alternative B are not enough to completely justify its initial investment. This makes Alternative B a high risk option.
3. Based on both of the sensitivity and scenario analysis, Project A would be more worthwhile for the company as compared to project B
References
Zabihollah Rezaee, . R. (2009). Financial Statement Fraud: Prevention and Detection. Chicago: McGraw Hill.
Block, Hirt, and Short, (2012), 9th Cdn. Edition, McGraw-Hill Ryerson Ltd., Toronto CASE STUDY, Foundations of Financial Management, McGraw Hill
