Assignment 4

Group Members
Hareem Shehzad
Mussadiq Nisar
Annas Aman

1. Which discount rate was used to discount the cash flows associated with the PCBs
project? Do you think this is an appropriate discount rate considering the risk inherent in
the project? Comment on any risk involved?

We followed the case study's recommendation and applied a discount rate of 15%. "The
company generally used a hurdle rate of 15% for net present value calculations (for projects
deemed riskier than usual a higher rate would apply)" from the case study, so it's clear that a
thorough risk assessment is needed to decide if the 15% discount rate is good for the project.
However, risk assessment is not possible due to the unavailability of data. What we can do is
look at the NPV and IRR of the project.

With an internal rate of return (IRR) of 32.3%, the project easily surpasses the 15% barrier rate.
In other words, the return on investment for the project is anticipated to exceed twice the cost of
capital. The expectation that a project will earn a return significantly higher than the cost of
capital is reflected in a higher internal rate of return (IRR), which in turn suggests a lower level of
risk.

NPV = $18,265,402: The project is anticipated to generate substantial value, as indicated by the
positive NPV. For the most part, people look favorably upon an NPV that is positive. A higher
net present value (NPV) indicates that the project is likely to generate more value.

The project is anticipated to not only meet, but also substantially surpass, the hurdle rate, as
indicated by the higher internal rate of return and positive net present value. Despite the positive
financial metrics, it is crucial to take other factors into account and perform sensitivity analyses
to determine how well the project can withstand changes to important assumptions. The
unknowns of making printed circuit boards (PCBs) in-house constitute the project's risk.
Possible difficulties in controlling the production process, attaining the anticipated savings, and
moving away from external suppliers are all part of this. It may be more prudent to use a higher
discount rate if these risks are significant.

2. What were your assumptions regarding the Terminal Value of the cash flows? Did this
assumption affect the decision to either accept or reject the proposal for insourcing of
PCBs? Should the terminal value be discounted at the same rate as the other cash
flows?
We are primarily assuming a 3% growth rate for the Terminal Value. Our proposal calls for a
steady 3% increase over the course of the project's lifetime, so this might be a significant
obstacle. The second assumption is that the hurdle rate won't change. This means that
investors' required rate of return will not be significantly affected by changes in market
conditions or the country's situation. Which makes these assumptions a bit irrational.

Assumption will influence decision-making, but it's a ray of hope in a dark tunnel without other
directions. Therefore, we have no choice but to continue with this option.

When trying to anticipate the hurdle rate, it can be problematic if we think it should be low but it
turns out to be higher than expected. The project's NPV could be inflated, making it more
appealing, and it won't be able to meet the investors' required return. We may decide to reject
the project due to a lower NPV if the predicted hurdle rate is greater than the actual one.

If the company has strategic plans, such as capital restructuring, to change the discount rate for
terminal value, that rate should stay the same. Otherwise, it could be adjusted. If they anticipate
a shift in the company's macro conditions in the coming years, it could also be revised.

3. Based on your work, what were the project's IRR and NPV? What is your decision
regarding the proposal based on these criteria? Are there any other issues that would
change your perspective on this proposal?

My analysis indicates an Internal Rate of Return (IRR) of 32.3% and a Net Present Value (NPV)
of $18,265,402. The positive NPV and the IRR higher than the WACC suggest that, based on
these criteria, the project is financially attractive.

However, other factors such as strategic alignment, operational challenges, or potential impacts
on existing supplier relationships might not be captured by NPV and IRR. Therefore, it would be
better to use other risk assessment techniques for better due diligence. Because it might affect
the WACC.

4. Do a sensitivity analysis of the project's NPV and discount rate and comment on the
risk level of the project?

The sensitivity analysis reveals that the project’s Net Present Value (NPV) is significantly
affected by variations in Free Cash Flow (FCF) growth and the Weighted Average Cost of
Capital (WACC). Under different FCF growth scenarios, the project shows a wide range of NPV
values, with optimistic growth projections increasing NPV and pessimistic scenarios decreasing
it. Likewise, changes in WACC indicate the project’s sensitivity to changes in the cost of capital,
with higher discount rates resulting in lower NPV. The project’s risk profile is thus complex and
can be considered high, requiring a careful consideration of trade-offs between potential returns
and associated risks. To mitigate this, we should focus on accurate forecasting, implement risk
mitigation strategies, and continuously monitor key variables to adapt to changing market
conditions and economic factors. Overall, a comprehensive understanding of the project’s
sensitivity to these critical parameters is essential for informed decision-making and effective
risk management.

WACC Sensitivity Analysis

WACC PV of FCF NPV

10% 48,690,335 42,403,077

15% 24,552,660 18,265,402

20% 15,061,540 8,774,282

25% 10,157,411 3,870,153

30% 7,247,088 959,830

NPV Sensitivity Analysis

PV of FCF NPV

FCF Pessimistic 2 $13,354,870

FCF Pessimistic $15,810,136

FCF Expected $18,265,402

FCF Optimistic $20,720,668

FCF Optimistic 2 $23,175,934