The company was founded in 1924 by Theo verdin a previous as a subsidiary of his dairy business. His keen attention to product Development and grew business steadily over the year .the company went public in year 1979 and by 1993, was listed on trading in the London and Germany exchanges.
In January 2001, the senior management of Euro land foods was to draw the firm’s one year capital budget and up for new 11 major projects are imposed to spending limit on capital of 120 million pound. Investment at that rate would be representing a major increase in the firm’s current assets base on 965 million pound. The senior manager challenge of Euro land foods to allocate funds among a range of compelling project, new product introduce and preventive maintenance, safety and pollution control.
As a matter of policy, investment proposals at Euro land
foods were subject to two financial test, payback and internal rate of return.
NET PRESENT VALUE (NPV)
The net present value (NPV) requires cash flow discounting by making use of the so-called risk-adjusted cost of capital, which serves the purpose of accounting for risk. A widespread model employed for computing the cost of capital is the capital asset pricing model (CAPM). Rubinstein (1973) and other scholars in the late 1960s and 1970s have provided the link between CAPM and capital budgeting decisions: in their classical contributions they show that, if the CAPM assumptions are met, then the cost of capital is a function of the systematic risk, which is given by the beta of the project. The latter depends in turn on the cost of the project, which implies that it is a disequilibrium beta. The corresponding NPV is therefore disequilibrium NPV.
If…
It means…
Then…
NPV > 0
the asset would add value to the definite
the venture may be acknowledged
NPV < 0
the asset would take from value as of the firm
the plan should be unwanted
NPV = 0
the asset would neither gain nor misplace value for the firm
We should be uncaring in the conclusion whether to accept or refuse the project. This plan adds no monetary value. Decision should be base on other criteria, e.g. designed position or other factors not evidently included in the calculation.
Formula:
Npv =CFo+ ___CF____
( 1+k) n
Example:-
Year
Cash flow
Present Value
0
100,000
1
22,727
2
20,661
3
18,783
4
17,075
5
15,523
Internal rate of return:-
It is a different economical cash flow practice which takes report of the extent and time of cash flow.
Formula: –
IRR=LOWER RATE+ npv at lower rate x (HIGHER RATE -LOWER Rate)
Npv at lower rate -NPV at higher rate
Example 1.
If a speculation may be given by the chain of cash flows:
Year (n)
Cash Flow (Cn)
0
-4000
1
1200
2
1410
3
1875
4
1050
Then the IRR r is given by
.
In this case, the answer is 14.3%.
1. Project with NPV and IRR:-
The research on the resource-constrained project scheduling problem is focused mainly on two types of objectives: objectives based on time and objectives based on cost. Both of these factors, i.e. time and cost, are indispensable in practical applications.
Year
cash flow
P v present value
0
1
2
3
4
-2000
600
600
600
600
-2000
600/1+0.08=504.20
600/1+0.08=423.70
600/1+0.08=356.05
600/1+0.08=299.57
Npv=-2000~+504+424+356+299= (-417) loss rejected
.
year
cashflow
pv present value
0
-2000
-2000
1
600
600/1+0.10=594.05
2
600
600/1+0.10=298.50
3
600
600/1+0.10=181.81
4
600
600/1+0.10=136.36
Npv=-2000+595+299+182+ 136.36 = (818) rejected
3) Project A.
Act tram plc examining two projects, A and B.
Discount rate= 8%
Npv =-240000+200000/1+0.08)1 +100000/1+0.08)2+200000/1+0.08)3=
-240000+185,185+85734+15877=46796
4) Project B:-
Npv =-240000+20000/1+0.08)1 +120000/1+0.08)2+220000/1+0.08)3=
-240000+185,519+102881+174643=56043 ok
5) Project A
R =16%
Npv=– Npv =-240000+200000/1+1.16)1 +100000/1+1.16)2+200000/1+1.16)3=
-240000+172414+74316+12813=19543
6) Project B:-
Npv=– Npv =-240000+20000/1+1.16)1 +120000/1+1.16)2+220000/1+1.16)3=
-240000+172241+89180+140945= 7366 accept
7) Project:-IRR
R=14 %
IRR=–11+ -4+ -10 +1+2+4+40=0
Then we try to discount rate to find rates that are gives a zero Npv.
Npv (approx.) o.o43 or -43000
At 13%
Npv = 932,000
13+932000/975000 X (14-13) = 13.96%
8) Project:-
R =19%
IRR=-11/-10/1+0.19+5/0.19/1+0.19= (-0.82m
Try 18 %
-11+-10/5/0.18/1+0.18=0.475
18+475000/1295000X (19-18) =18.37%
SECTION B
Appraisal technique
The formal method of project appraisal, so word a warning is necessary at this point .mathematical technique is merely one element needed for successful project appraisal. The quantitative analysis is only the starting point for decision making .the real-world situations there are many quantitative factors to need to taken into account. The management is largely an art form with a few uses full quantitative technique to improve the quality of art
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1). Strategy
The relationship between the proposed the project and the stagey direction of the firm is very impotent’s business unit investment isolated from the main trust of the firm may be a direction in term of managerial attention and functional resource .A project that look good at divisional level may not appropriate when examined form the whole -firm perspective .it is for firm goals. Then project judged on its own perspective to very high npv but there is a danger of losing the premium brand strategy position in existing product ranges of association.
2)-social context
The effect on individual is a crucial consideration the project require to people to implement them. Their enthusiasm and commitment will be of central importance. Discussion and consensus on ect proposals may matter more than selecting the mathematical correct option. In quantitative technique is avoided because they are precise .it is safer to sponsor a project judgemental way the early stage in its development if a result of discussion with colleagues and supervisor and managers. General report are present the top management and commitment and support of project to need the lot of peoples then they decided.
3):-expense
Project evaluation the project can be cost a consideration export on the input is costly cost enough, but the firm also to have workout this project then the manger and supervisor are devote to good quality and search the project information to the market dept to few quantities .
Management and Project
Seven senior manages of euro land foods are prepare the project .for project are consideration each project had to sponsored by one manager. The decision process include a period of discuss by on two to four alternative capital budgets.
a) Detail of project
1. Replacement and expansion of the truck fleet
2. A new plant
3 expansion of a plant
4 development and rollout of snack foods
5. Plant automation and conveyor systems
6. Effluent water treatment at four plants
7. Market expansion southward
8. Market expansion eastward
9 development and introduction of new artificially sweetened yogurt and ice cream
10. Networked computer -based inventory control system for warehouses and field representatives.
11. Acquisition of leading schnapps brand and facilities.
b) Analysis of project according to company:-
Project 1-
Heinz Klink proposed to purchase 100 new refrigerated tractors -trailer trucks, 50 in 2001 and 2002.The Company sell 60 old truck fully depreciated over the two year for total amount 4.05 million. The purchase expand of and the fleet by 40 trucks two year .The new trailer are larger the old and 15% increase in cubic meter of goods for one trip. The new tractors also be more fuel and maintained-efficient.
(The company are going to loss in IRR).
Project 2-
The euro foods yogurt and ice cream sales in the south-eastern region of company’s market were about other country capacity of plants of packing. The France and other country are shipping cost are very high. The proposed a new plan of manufacturing and packing plant to expand the food market. The cost of plant 37.50 million and entail 7.5 million .they increase the sale and delivery cost decrease .This project was expected to yield after tax cash flow totalling 35.6 million and IRR of 11.3% over the 10 years.
(This project is rejected on payback.)
Project 3.
In addition they need the more production in euro foods in sauternes region .they have problem to routine equipment maintainers and also production deadline problems. The equipment 10.50 million would deprecation on 7 year.
(This project is rejected on payback.)
Project 4.
This company part produce excess its Antwerp spice and nut-processing and produce a line of dried fruit to other country. They discuss about reputation of euro foods in market .they produce high quality.
The equipment capital investment were expect total 22.5 million and 4.5 million for this project are also see that more expansions. The IRR was expected 13.4% above the required return of 12% for new product projects.
(This project is rejected on payback.)
Project 5.
Marten Leyden also requested 21 million increase of production in line six of the company older plants. The result would improve throughput speed and reduce incident spillage in production. The average hour’s total compensation rate 14 an hour’s more than 150000 a year were lost. Cost of saving and deprecations 4.13 million a year for the project and were expected an IRR 8.7%.
(This project is rejected on payback.)
Project 6.
The euro foods prepared a variety of fresh fruits .The one of stage are cleaning fruit and remove dirt. The project financial cost 6 million and same equipment cost could be 15 million in four years.
(This project is accepted.)
Project 7 and 8:-
Marco ponti recommended that the company expand its market southward and eastern country .The Company believed that the same time to expand sales of ice cream and yogurt .the Company expand to eastern market and face the competition for local market ice cream to different country.
The cost of proposal 30 million working capital .in this proposal distributor involve but over the 10 year forecast period. Expansion proposal assumed the rental of suitable warehouse and distribution facilities .The after -tax cash flow s were expected to total 56.30 million for southward expansion and 48.8 million expansions.
Marco ponti pointed that expansion meant higher possible IRR but that moving was low risk. The project IRRs were 21.4% and 18.8% for expansion and 48.8 million.
(This project is accepted.)
Project 9.
Fabience morin noted recent development in artificial sweeteners were showing promise of significant cost saving to food and beverages producers as well as stimulating growing demand .In addition 27 million would be needed to commercialize a yogurt line that had received promising result in laboratory test. The overall IRR was estimated to be 20.5%.
(This project is accepted.)
Project 10:-
Heinz Klink had pressed unsuccessfully for three year for a state of the art computer based inventory control system that would be link field sales representatives .The present cash flow forecast however they initial outlay of 18 million for system, following by 4.5 million in the next year .The project was IRR estimated to be 16.2%.
(This project is accepted.)
Project 11-
Humbolt had advocated making diversifying in an effort to move beyond the company’s mature core business, but doing so in a way that exploited the company skill in brand management. They have talk with each; he had determined that only one company could be purchase in near future namely the leading private European manufacture of schnapps located in Munich.
The proposal was expensive 25 million to buy the company and 30 million to renovate the company facilities completely while simultaneously expanding distribution to new geographical market. The expected returns were high after tax cash flow was projected to be 198.5 million and IRR of 27.5%. .
(This project is accepted.)
Critical Analysis:-
Sunk cost
A sunk cost is an outlay that has already Occurred, hence is not affected by the decision under consideration .since sunk charge are not incremental costs, they have to not be include in the analysis .The sunk cost will not affected future cash flows regardless of whatever or not at the new project is implementation .it often turn out the particular project are Npv has negative ,if future cash flow large and enough to incremental cash flow to produce a positive npv on the incremental investment.
Divisibility
A divisible project may be split into number of separate parts, each capable of undertaken on its own. If the project is indivisible then the entire project must be undertaken .In the capital budgeting, financial manager will often face problem with project divisibility.
Opportunity.
The money you have now you could (in principle) invests now, with grows return or interest, stuck between now and the prospect time. Funds you will not have awaiting a prospect time cannot be used now.
Risk.
Cash you have now is not at danger. Money predicted to reach your destination in the future is less certain.
Inflation.
A calculation you have today will very possible buy more than an equivalent sum you will not include until years in future. Rise over time reduces the buying power of money.
SECTION C
Qualitative and quantitative factors
1) Present a mathematical base for choice making – reduce decisions to looking at a financial value placed on diverse choices, e.g.
Forecasted sales data
for the after that 5 years
The price of a succession of redundancies
next to the longer term monetary benefits
to the firm of this price.
2) Qualitative factors appear to take report of these other issues
that may pressure the ending of a decision can be wide ranging and specially need to consider the impact on person income and their comeback to decision.
Conclusion
The case study shown that there has been a lost emphasis in the literature regarding certain aspects of investment appraisal. The so-called reinvestment assumption, so prevalent in the literature, for so long, has been shown not to be responsible for the well known conflict between the NPV and IRR methods. When markets are perfect direct incorporation of reinvestment opportunities will not change the original NPV rankings. If capital markets are imperfect direct incorporation of reinvestment opportunities into the decision process is of paramount importance to the company and/ or investors. The euro land foods capital budget of 120 million.
It is, therefore, important for analysts and investors to be familiar with the problem of reinvestment. Analysts /investors should, in appraising investments, be encouraged to use the NPV method in preference to the IRR method, for the latter may yield inaccurate results.
Recommendation
NPV assume that project cash flows are reinvested at the company’s necessary rate of return; the IRR assumes so as to they are reinvested at the IRR. Since IRR is superior than the requisite rate of return, in order for the IRR to be precise, the business would have to keep judgment project that would reinvest the cash stream at this superior rate. It would be solid for a company to remain this up eternally, thus NPV is more precise. NPV method project value more straight than IRR. This is since NPV actually calculate the project’s value. If to hand is extra than one project wrinkled up, the executive can simply add the values mutually to get a total. Often times, during the life of a method, cash flows must be reinvested to cover up decrease. This will give a off-putting cash flow for that period, thus central to more than one IRR. If at hand is more than one IRR, than conniving only 1 IRR for the project is not even. NPV must be used for this type of scheme.
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