Investment Proposal for Cengage Learning, Inc.
Executive Summary
Purpose of the Paper
The main purpose of the paper is to prepare an effective investment appraisal for Cengage Learning by using various financial management tools.
Overview of the Paper
The paper comprises of following material that can be seen in the overall paper.
Investment appraisal techniques for introducing new product line
Selection of two most common techniques
Importance of techniques through literature
Testing of Feasibility of new project
Interpretation and conclusion on the analysis
Techniques Used
Results
It is found from the above two analysis that the project is viable for the company and has potential to provide high return in the coming years. The results are prepared on the basis of these grounds.
The fair equity value per share is greater than current share price of the company.
The amount of investment will be recovered in 2.69 years from the beginning.
List of Tables
Financial management refers to the management of money that is controlled and managed by the upper management of an organization. The main component of the financial management is a new product investment proposal. It is necessary to assess various risks and opportunities while introducing new products in the market. There are many traditional and modern techniques to determine the profitability or success of the new venture. The investment proposal is prepared for a publishing company that should analyze some important factors before decision-making.
1.1 Cengage Learning, Inc. Overview
Cengage Learning is a publication company that is headquartered in Boston, Massachusetts. It was found in 2007. It operates in a global environment, and it has offices in more than 20 countries. The operations of Cengage include creating and maintaining databases that are published in print and online. The products of the company include educational publishing for schools, businesses, and libraries. It is specialized in providing custom solutions and test preparation materials, and academic principles to guide students in their career development. It has acquired various assets such as Education to Go (2004), Pal Publications (2008), and Pathbrite, Inc. (2015). More than 5,500 employees are currently working in different countries.
1.2 Importance of Investment Appraisal Process
Investment appraisal is the main component of financial management or capital budgeting that refers to the assessment of expected returns and estimations of future benefits and costs associated with the specific project. Götze et al. (2015) state that, “The key concept relevant to investment appraisal is that an investment project is characterized by a serious of cash inflows and outflows over several time periods” . It shows that it contains all relevant costs and expenditures that are associated with the project, and the concept is helpful in determining the factor that it has potential to provide long-term benefits or not. It is obvious that finance is needed to start a new project after planning. It is mandatory for every new project such as introducing a new product to analyze its overall feasibility (Bilych, 2013). Moreover, a new project or venture requires heavy investment that may be borrowed from an investor, so it is also crucial to satisfying them by providing a feasibility report that comprises of two main areas that are mentioned below.
1.3 Investment Decision Making
The investment appraisal methods are widely useful for making decisions for investment. The analysis is essential to identify the return and risks associated with the specific project. The investor demands the plan that is prepared for the project so he could take a viable decision making for involving in the project. The decision of the project planner that is the company undertaking the project should have an effective reason for selecting the project, and there should be no leverage in it. All the analysis should be conducted properly to provide easiness and simplicity to stakeholders and the company. The company should take decisions on the basis of these analyses that are considered most important in investment appraisal.
Descriptive Section
It includes all descriptive analysis regarding the external environment in which a company operates. It also contains details of risks and opportunities that are revealed through market research. The plan is also mentioned in this section along with the tasks that would be executed by different team members working on the project. It may also consider the description of what is to be carried out for stakeholders to provide them a clear view of the project. Moreover, the descriptive section is also prepared to satisfy the investor that the amount of investment is being used in this way .
Financial Information
Financial information includes costs and expenditures that will be incurred in a given time on the specific project. It also contains various analyses such as discounted cash flows and payback period that clearly explains the overall scenario regarding figures. The financial information helps in presenting a quick review to the user regarding the estimations made on future cash flows. The investors of the project should have knowledge regarding the estimations made by the project planner so he could make a viable decision for investment in that project .
2. Theoretical Position of Investment appraisal Techniques
2.1 Discounted Cash Flow Technique
A discount cash flow (DCF) is a method used for the estimations of the attractiveness of specific investment opportunity. It is widely used to determine the present value of future cash flows to assess the potential for investment (Warren et al., 2013). The workings of IMA states that “Net Present Value (NPV) uses a specified discount rate to bring all subsequent net cash flows after the initial investment to their present values at the time of the investment” . It explains that NPV is the main component in DCF analysis that discounts all future net cash flows at the beginning of the project. The formula that is used to calculate DCF is as follows.
Formula
DCF = CF1 / (1+r)1 + CF2 / (1+r)2+.. + CFn / (1+r)n
Here,
CF = Cash Flow
r = discount rate (WAAC)
2.2 Payback Period Technique
Payback period is defined as the time in which the total cost of an investment is received. It is a traditional approach that is used to determine whether the project is viable or not. It does not consider other components such as time value of money, present value, or future cash flows. The calculation of payback period relies on the fact that whether cash flows are even or uneven. In general, companies do not estimate even cash flows over the period as it is unusual that it earns a similar amount of profits every year (Besley & Brigham, 2014). The formula for calculating payback period of uneven cash flows is.
Formula
Payback Period = A + (B/C)
Here,
A = Last period with negative cash flows
B = Cumulative cash flow value at the end of period A
C = Total Cash Flow in the next period of A.
3. Criticism on Various Methods of Investment Appraisal
The two methods discussed above are relevant for investment appraisal as mentioned by various authors in their studies. Bilych (2013) clearly states, “If the theory of time value of money allows investors to analyze their future benefits, the rule of net present value (NPV) allows them to understand generally the feasibility of investments”. It represents that investors are willing to analyze the overall current and future conditions of business so there is a need for a suitable method that can provide an overview of future benefits in current times. It reveals that NPV is the most important factor in analyzing the financial position of business before making decisions for investment. Also, an investor is concerned about the future benefits that is a long-term return on investment and risks associated with it, so time value of money is helpful in analyzing future benefits associated with the project or business. On the other hand, Payback period is different from DCF method as it considers only the estimated time in which the entire investment will be recovered. Alesii (2006) supports Payback method by explaining that “PBP computation is performed cumulating C Ft until the initial investment is completely recovered” . It shows that Payback method is not the oldest technique, but the development is made in this technique that can satisfy the user at large. Now it also considers various investment risks and can be used to calculate and evaluate the feasibility of the new project. Hence, it is clarified from the above discussion that any of the two methods is useful for users in assessing the profitability and reliability of a new project.
3.1 Key Critical Observations
The discussion on the importance of the two methods provided in the above section is relevant to the topic. However, there are some critical observations derived from the discussion of various authors. .
DCF method is useful in capital budgeting
DCF is used to calculate time value of money
Present value calculation is the key component in DCF
Payback period is useful only for determining the time period of return on investment
Payback period does not consider risk factor
Investment decisions cannot be made on Payback period.
Moreover, there is a need of observations in which the proposed investment techniques are applied that can help in interpreting the results. The parameters in which DCF and payback period are tested are given below.
The techniques are extensively
4. Investment Proposal
The main objective of the paper is to prepare an investment proposal for six years for Cengage Learning by using various methods of investment appraisal. The scenario is clear that the company intends to introduce its new product that is moving towards digital product named, “Nursing Education to Students SIII3 A. 2017”.
4.1 Descriptive Information of the Digital Product
The product will allow customers to engage with the company and learn various concepts of nursing that would be helpful in building a career. The expected life of this product is 15 years, and it will incorporate all cultural and traditional dimensions of nursing profession that will help in developing new skills in learners. The digital product is expected to show high profitability in the long run as nursing students are willing to gain knowledge for enhancing their capabilities before entering in their professional phase. The product is prepared to depend on the global market conditions and preferences of a new generation that has a lot of questions to be asked for this profession. The product is expected to become popular in the global market as it attracts new comers to gain relevant information by asking questions. The digital product is unique as it enhances the learning and education of students by getting engaged in the videos provided to them. It has been introduced according to the new culture of learning in which students are willing to have visual representation of what is being taught to them.
4.2 Financial Information of the Digital Product
It is essential to estimate and predict whether the new product has potential to provide a high return in a short or long run. It explains that estimated cash flows should be prepared to analyze the costs and benefits associated with the new product. It should be noted that future costs and benefits are required to analyze at present to determine whether it is a viable project or not (Götze et al., 2015). Also, the investment analysis is done by determining cash inflows and outflows within six years. The investment appraisal method (DCF and PBP) are used a tool to determine the profitability and a potentiality of the new product.
4.3 Estimated Cash Flows for 6 Years
The estimated cash flow is prepared on various assumptions that are made on market research and estimated conditions of market and industry. These assumptions are helpful in understanding the estimated cash flows for the new product.
It should be noted that all the assumptions are incorporated in the estimated cash flow table provided below.
The above-provided cash flows represented all relevant and expected cash inflows (revenues) and cash outflows (Expenses). It provides detail of expenditures such as marketing and administration that are likely to incur during the execution of the project. The initial investment required for the project is 1,000 million that will be financed through equity as it has a vast portion of equity reserved. It can be observed in the cash flows table that net cash flows are increasing rapidly because of the growth of five percent in three years and ten percent after three years. The positive change is shown due to the less change in expenses that regards to inflation and other external factors (Warren et al., 2013). In short, it is the summary of all cash inflows and outflows that are expected to incur during six years.
4.4 Discounting Cash Flows Analysis
The discounting cash flows for the new product is provided in the following table.
The above-provided table is prepared to present simple and clear information that is extracted from cash flows table that is the net cash flows of six subsequent years. The third column of the table represents the calculation of each year cash flows and the total is calculated to make comparison that is explained through the next table provided below.
The above-provided table shows the comparison between equity fair value per share and current share price of Cengage. It can be seen that equity value per share is more than the share price that indicates the project is viable (Alesii, 2006). The high value of equity per share represents that the investment project is profitable and less risky that is the attractive point for the investor. It should be noted that the results found in this analysis are based on various assumptions, and there is a need of another analysis that can determine the period in which the investment can be recovered.
4.5 Payback Period Analysis
Payback period is the traditional method used to determine the feasibility of the project that is the determination of time in which the entire investment will be recovered. It can be seen in the following table.
The above-provided table represents that the investment will be recovered in 2.69 years from the beginning. It shows that it is a viable project that will take a short time to return the investment. The payback period is also helpful for the company to assess after the end of 2.69 years that whether the investment is recovered or there is a need to change the strategy to ensure a high return.
4.6 Practical Issues Identified
Although the methods used in this paper are useful for investment appraisal some drawbacks or weaknesses are found in the application and calculation. The major issue identified in both the method is the lack of estimation of various investment risks that may arise due to recession or competition in the country or market. It is the main factor in the investment appraisal that is considered extensively by an investor (Besley & Brigham, 2014). The ignorance of this factor may cause difficulties in assessing the performance of the project in the long run. Another practical issue is found in the calculation of DCF that it considers the discount rate based on market conditions that may change due to the change in external factors. Also, the estimations including growth are prepared according to assumptions, and this does not show actual or predicted rate. The expected growth rate is applicable, but there is a need to analyze the growth rate of past few years for the determination of expected growth rate in future. The trend requires to be followed in the same manner, and there should be no leverage in preparing DCF for the new product that is indeed a critical task (IMA, 2014). The last issue is related to payback period analysis that it solely deals with the net cash flows and represents the time that will be required to recover the entire amount invested in it. These practical issues are also the limitations of methods used in this paper (Bilych, 2013).
5. Conclusion
Investment appraisals methods are associated with capital budgeting that also include financing of projects. The relevant methods or techniques used in the paper are helpful for every company while introducing a new project. It can be concluded that DCF analysis and payback period are required to be followed by Cengage Learning to introduce new product line in the market. The paper has also described the relevance of these methods in investment appraisal that is also evident in the various literature. However, there are some other methods such as Internal Rate of Return (IRR) that is also helpful in assessing the feasibility of a project, but it is suggested that companies do follow these methods that are DCF and payback period to check the reliability and profitability of a company. It is also viable for a long-term project that is for 15-30 years in which long-term investment is required, and it also ensures high long-term return. In short, the methods used in this study are helpful in assessing the plan and execution of the project that will help the company to gain competitive advantage in the industry.
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List of References
Alesii, G., 2006. Payback Period and Internal Rate of Return in Real Options Analysis. Engineering Economist. , 51(3), pp.237-57.
Besley, S. & Brigham, E.F., 2014. CFIN4. Mason: Cengage Learning.
Bilych, A.V., 2013. Theoretical and practical aspects of business valuation based on DCF-method (discounted cash flow). Economy of AIC, 5(8), pp.78-84.
Götze, U., Northcott, D. & Schuster, P., 2015. Investment Appraisal: Methods and Models. New York: Springer.
IMA, 2014. Wiley CMAexcel Learning System Exam Review 2015 + Test Bank: Part 2, Financial Decision Making, Part 2. Hoboken: John Wiley & Sons.
Warren, C.S., Reeve, J.M. & Duchac, J., 2013. Managerial Accounting. Mason: Cengage Learning.
