ASSIGNMENT COVER SHEET

UNIVERSITY OF THE WEST OF ENGLAND

MSC IN FINANCE

Student ID: 18045443

Student Name: Khuat Xuan Quynh

Module Code: UMACTA-30-M

Module Name / Title: FUNDAMENTALS OF FINANCE

Centre / College: Banking Academy of Viet Nam

Due Date: 8 Jan 2019 Hand in Date: 8 Jan 2019

Assignment Title: Coursework

Students Signature: (you must sign this declaring that it is all your own work and all sources of
information have been referenced)

For University only

MARK RECORD

1st Marker

2nd Marker

INTRODUCTION

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TABLE OF CONTENTS

INTRODUCTION........................................................................................................3

EMPIRICAL RESULT.................................................................................................3

Sensitive analysis......................................................................................................3

Financial factor analysis..........................................................................................5

Non-financial factor analysis..................................................................................5

Recommendation.....................................................................................................6

The gap between theory and practice.....................................................................6

APPENDIX................................................................................................................... 7

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INTRODUCTION
Foster’s Construction Ltd (“FCL”) is a private company, of which main business activity is to
construct and maintain large industrial buildings. Founded in early 1990’s, the company has
earned a good reputation in the marketplace. Even though the national inflation rate has been
remained at 4%, and expected to stay the same in the near future, FCL’s annual revenue is
likely to reduce by around 3% due to the influence of economic downturn.
The company is facing a capital investment decision of whether it should purchase a new
crane to replace the existing ten-year-old one. Details for the two options are as below:
- Option 1: replace the old crane with the Auto-Lift II (“ALII”), a more advanced model with
up to date technology and can lift much heavier loads. ALII‘s purchasing price is £345,000
and annual running cost is £60,000. After its ten year useful life, FCL should be able to
collect of scrap of £30,000.
- Option 2: spend £40,000 on maintenance to keep the old crane for five more years. The
running cost is only £40,000 per year, but chance of breakdown within the next twelve
months is 50%. For every time the crane broke down, it costs a £10,000 fixing cost and a
three-day productivity (around £15,000).
Considering the importance of a crane to construction companies, the management board of
FCL is taking the matter seriously. The board all agreed that multiple factors should be taken
into account before final decision is made.
EMPIRICAL RESULT
Sensitive analysis
Sensitivity analysis is a risk analysis method, used in determining the movement of
independent variables toward dependent variables, provided that specific assumptions are
met. This report examines the sensitivity of taxation rate and discounted rate on net present
value of both options.

Graph 1 was built based on the discounted rate of 26%, which is the adopted rate by FCL for
years. The graph shows changes in NPV for both option when tax rate fluctuates. The
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negative figures of NPV indicates that total cash out-flowed overweighed total benefit
gained. As such, it can be seen on the graph that replacing the old crane immediately will cost
FCL more money than waiting for five more years. Furthermore, if the range of tax rate is
expanded further forward, the two lines will tend to move further and further to each other. It
means the higher the tax rate is, the more expensive option 1 will be in comparison to option
2.
However, it is noted from the case study that FCL is setting a discounted rate that is too high
for a crane (i.e. 26%) and is mistaking discounted rate and nominal rate. Recalculating
discounted rate with a proposed nominal rate of 21% leads to a discounted rate of only 16%.
As shown in Graph 2, at 16% discounted rate, option 1 is providing a cheaper cost for the
firm.
Graph 2 illustrates the movements of NPV when discounted rate changes and tax rate remains
at 35%. From around 22% backward, option 1 is a better choice since it offers a smaller
expense and vice versa. It explains why option 1 is less attractive than option 2 when the
discounted rate is 26%.

Due to the fact that FCL is mistaking the two definitions of nominal rate and discounted rate,
option 1 actually creates a more efficient cash flow for the company in both analysis. As
proof, graph 3 re-demonstrates the sensitive analysis with a discounted rate of 16%. Option 1
turns out to be a much more cost saving choice.

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Clearly, if only considering the influence of tax rate, option 1 will be removed. Learning from
that, in order to make the proper final decision, more financial and non – financial factors
should be considered.
Financial factor analysis
Budgeting is the first financial factor to think through. The initial needed budget for option 2
is only £40,000 and it has already been planned since the beginning of this year. If going with
option 2, FCL can probably self – fund by using its equity. In contrast, the initial required
budget for option 1 is £345,000. Self – funding would lead to a liquidity problem since the
amount of money is quite big and unexpected. Therefore, if FCL decided to replace the crane
immediately, budgeting would be another obstacle. The firm will have one single month from
decision date to prepare the fund, so one of the possible ways to avoid cash shortage is to put
down an initial payment of £40,000 and ask a financial institute, such as a bank, to sponsor
the remain.
Inflation is another financial factor that could affect the investing decision. Unstable inflation
rate will cause the economy unsteady and interest rate higher. Based on the case study, the
inflation rate is hoped to stay at 4% so FCL can forecast the future cash flow pretty
accurately.
Non-financial factor analysis
FCL’s strategy is to keep up with the newest technologies in the industry so that it can
enhance the corporate image of an innovative construction firm. It is agreed that the good
corporate imagine is one of the company’s best assets and has helped to secure many
competitive contracts over years.
Once the new crane is on duty, the modern technology brings along both benefits and
difficulties. FCL will be more technically advanced against most competitors and will have
the capacity to expand market share. However, its staff needs to be trained intensely to adapt
and take full advantage of the new crane.

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Recommendation
After pondering all of the aforementioned factors and analysis, buying a new crane
immediately is obviously the better option for FCL at its current position.
The gap between theory and practice
Besides all mentioned aspects, there exist other elements that could direct the capital
budgeting decision such as regulation, political environment, or human resource. Some
factors are uncontrollable so it is impossible to predict their impacts. As a result, despite
cautious analysis, there is still a gap between theory and practice of capital budgeting.

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APPENDIX
Table 1: NPV at discounted rate of 26% when tax rate changes

NPV of Old NPV of New

Tax rate
crane crane
15% (281,740.76) (294,354.27)
20% (271,738.08) (286,102.96)
25% (261,735.39) (277,851.65)
30% (251,732.71) (269,600.34)
35% (241,730.03) (261,349.03)

Table 2: NPV at discounted rate of 16% when tax rate changes

NPV of Old NPV of New

Tax rate
crane crane
15% (379,697.62) (311,780.29)
20% (363,952.63) (300,290.51)
25% (348,207.65) (288,800.72)
30% (332,462.67) (277,310.93)
35% (316,717.68) (265,821.15)

Table 3: NPV at tax rate of 35% when discounted rate changes

Discounted NPV of Old NPV of New

Rate crane crane
10% (379,563.61) (274,951.65)
16% (316,717.68) (265,821.15)
20% (282,906.02) (262,891.66)
22% (268,023.58) (262,067.19)
26% (241,730.03) (261,349.03)