The terminal value at present is worth $143 million of the NPV. If we break down the variables that go into the terminal value, however, we notice that the cost savings are critical. If SGA expense is not reduced, then the terminal value is reduced to $67 million and the total NPV for the entire project ends up being $98 million. This figure is less sensitive to the change in cost of goods sold.
We should also consider testing combined sensitivity of our shakiest projections. Sales may not live up to expectations and cost savings might not occur. If we assume no net income and no additional cost savings, the project will have an NPV. If we assume that our expectations for these will be cut in half, the project has an NPV of $121million. This is significantly lower than the original projection, but still well above the $95 purchase price.
7) If I were CEO of Nelson, I would approve the purchase, based on its positive net present value. I would, of course, seek a lower price, to reduce the risk to our company. The project clearly has a high NPV, but more importantly it withstands our sensitivity analysis. It would take a doomsday scenario for this purchase to have a negative NPV. That is something we can assume with any capital investment. The most important sensitivity analysis, where we scaled back our most optimistic scenarios, had this with a positive NPV by around $35 million.
The main value in Northwestern is in overhauling the existing businesses. We feel that the current management team has been inefficient, but we are comfortable with the fact that they were ready to move on. We will need to invest in bringing in our own people but we feel that in doing so, we will be able to enhance the value of the existing Northwestern operations to a degree that justifies the cost.
The most important caveat is that we do not fully understand how this will impact Nelson and our strategic goals. We understand that at present we would like to secure a reliable source of wood chips. This would result in us increasing our reliance on Northwestern. As a consequence, we feel comfortable that the business will continue to be viable for many more years. Even taking a conservative estimate with respect to the terminal growth rate, we feel that the value of the ongoing Northwestern business is substantially higher than the current asking price. The fact that management of Northwestern has been so rigid in the past, yet the company has continued to be profitable throughout that period, we feel is an indicator of the strength of that business.
We see that the company, despite slow housing starts and poor management, was still profitable the past couple of years. When housing starts are high, the company is very profitable. With our cost-cutting expertise and better management, we are comfortable that we can extract significant value from Northwestern. Even if we meet more resistance than anticipated, the deal is still going to be profitable under almost any circumstance.
Exhibit A:
Ely, Bert. (2008). Savings and Loan Crisis. Concise Encyclopedia of Economics. Retrieved May 13, 2009 from http://www.econlib.org/library/Enc/SavingsandLoanCrisis.html
Damodaran, Aswath. (no date). Closure in Valuation: Estimating Terminal Value. Stern School of Business. Retrieved May 13, 2009 from http://pages.stern.nyu.edu/~adamodar/pdfiles/eqnotes/dcfstabl.pdf
Breierova, Lucia & Choudhari, Mark. (1996). An Introduction to Sensitivity Analysis. MIT. Retrieved May 13, 2009 from http://sysdyn.clexchange.org/sdep/Roadmaps/RM8/D-4526-2.pdf
No author. (2009). Weighted Average Cost of Capital -- WACC. Investopedia. Retrieved May 13, 2009 from http://www.investopedia.com/terms/w/wacc.asp
Franchise South Coast Railway is evaluating a proposal for a five-year franchise from the UK government. This proposal would be to operate a high speed commuter rail service from 2018 to 2022. The following report will examine the financials relating to this decision, and the decision-making heuristic. Decision-Making The decision at hand is essentially a capital budgeting decision. There are a few different ways to evaluate a capital budgeting decision. The most common
Capital Budgeting and Government Regulations Airline Industry LONG-TERM CAPITAL BUDGETING IN AIRLINE INDUSTRY Government regulation: Why or why not Major reasons for government involvement in a market economy Interests of stockholders and managers: The convergence Airline: Merger or new capital investment LONG-TERM CAPITAL BUDGETING IN AIRLINE INDUSTRY For profit organizations have shareholder's profit maximization as the main aim to pursue. Traditional managerial economics expects that all projects/investments having positive net present value (NPV) shall be initiated by
1 0.107 0.107 1.788005 4.37% 7.24% D 20 Lev 1.2925 0.120475 0.11038 1.653411 4.05% 7.22% D 50 Lev 1.87 0.1609 0.16045 -0.1731 -0.44% 7.05% 5. The only project that is unacceptable is Project D. At the 50% leverage level. This has a negative NPV. The other projects at each leverage level all have positive net present values. The following graph shows the NPVs for the different projects: 6. My objective in making this decision is to maximize firm value. The projects are mutually exclusive. I would use NPV as the main
When a range of options are presented to management, the capital budgeting process must be used to determine the costs and cash flows associated with each option. However, the capital budgeting process is only as valuable as the inputs and assumptions. If the assumptions are not grounded in reasonable analysis and quality research, the process will not yield a valuable result. If the numbers that are input into the
"MIRR: A better measure." Business Horizons. 51(4), 321-329. Cited in: http://econpapers.repec.org/article/eeebushor/v_3a51_3ay_3a2008_3ai_3a4_3ap_3a321-329.htm McClure, B. (n.d.). "Taking Stock of Discounted Cash Flow." Investopedia. Cited in: http://www.investopedia.com/articles/03/011403.asp?partner=answers "Modified Internal Rate of Return." (2009). Cited in: http://www.thinkanddone.com/finance/mirr.html Parrino, R, & D. Kidwell. (2009). Fundamentals of Corporate Finance. (Vol. 1, Ed.). Wiley Custom Solutions. Smart, S. And WL. Megginson. (2008). Corporate Finance. Thompson Learning. Sullivan, A. And S. Sheffrin. (2003). Economics: Principles in Action. Prentice-Hall. The IRR is the rate of return that makes the
Capital Budgeting If the discount rate is 0%, the project's NPV is $670,000. If the discount rate is 2%, the project's NPV is $614,353.50. If the discount rate is 6%, the project's NPV is $514,815.60. If the discount rate is 11%, the project's NPV is $408,997.50. The project's modified internal rate of return is 39%. The chart will show that the net present value is zero will at 46%, as this
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