University of Strathclyde

Department of Accounting and Finance

M.Sc. [Finance]

(Sept/2011)

Excel Assignment 40911-Computing for Finance and Financial Analysis (Excel) Name: Abhinav Kumar Registration No: 201152011 Lecturer: Donald Campbell

Date of Submission: 02/12/11

Table of Contents

1) Introduction3

2) Answer 14

3) Answer 26

4) Answer3.7

5) Answer411

6) Answer513

7) Conclusion..13

Bibliography14

Introduction:
This report deals with producing Capital Budget from available information and using this to select best of two possible projects. Company Background: Lens Lenses Ltd is a manufacturer of a wide range of optical devices including magnifying glasses, spectacle lenses and microscopes. The managing director, Leonard Penzias, has decided to expand his product range into the telescope market. There are two markets but hes only prepared to authorize one product. Project A): AstroChamp; a small, refracting (lens-based) telescopes aimed at children. Relatively low-cost, low margin, these will be placed with an existing distributor; Scottish catalogue-based shops, Angus Stores. This outlet is expected to give a high sales volume. Project B): Barnard ZX Pro; a high-quality Newtonian reflector (mirror-based) telescope aimed at adult hobby astronomers. This will be a high-price, high-margin product with low expected sales volume. Different tools in excel like Scenario Manager and Solver would be used to evaluate the projects.

Answer 1)
The Lens Lenses should proceed with project A for investment. Capital Budget was setup for each project. Tax calculation was done followed by calculation of net cash flows. NPV and IRR were finally found using the financial functions. The results of my working in Excel are shown below:-

Project B NPV IRR 6,86,153.22 28.987%

Project A NPV IRR

8,25,133.16 83.873%

Major Calculations:NPV = -Investment + Net Cash Flows discounted to Year 0

NPV(A)

-420000

456400/(1+0.0991)

291524/(1+0.0991)2

277060.97/(1+0.0991)3 + 264225.78/(1+0.0991)4 + 460156.72/(1+0.0991)5 155249.23/(1+0.0991)6 = 8,25,133.16 NPV(B) = -1195000 + + 474050/(1+0.0991) 419117.22/(1+0.091)4 + + 403867.58/(1+0.0991)2 1056381.07/(1+0.091)5 +

408084.33/(1+0.091)3 242666.59/(1+0.091)6 = 6,86,153.22

To find IRR, we equate NPV to 0 Project A: 0 = -420000 + 456400/(1+irr) + 291524/(1+irr)2 + 277060.97/(1+irr)3 + 264225.78/(1+irr)4 + 460156.72/(1+irr)5 155249.23/(1+irr)6 IRR = 83.873% Project B: 0 = -1195000 + 474050/(1+irr) + 403867.58/(1+irr)2 + 408084.33/(1+irr)3 + 419117.22/(1+irr)4 + 1056381.07/(1+irr)5 242666.59/(1+irr)6 IRR = 28.987% As can be seen above, Net Present Value (NPV) and Internal Rate of Return (IRR) for both projects were calculated. Both NPV & IRR are higher for Project A. NPV is the present value of all future cash flows minus the investment. It shows the excess or shortfall of present value of cash flows after financing. IRR is the rate of return that makes the NPV = 0. The higher the IRR, the more desirable it is to undertake the project. It is clear from the results, that Lens Lenses should undertake project A.

Assumptions: All units produced are sold. All production for whichever project is chosen will finish in year 5. Both products will be sold through retailers and the quoted prices are those paid to the company by the retailers.

Answer 2)
Discount rate is changed from 9.91% to 7.52%. Scenario Manager was used to find the New NPV. The scenario summaries are as shown below:

Project A Scenario Summary Current Values: Changing Cells: $C$38-Discount Rate Result Cells: $D$38-NPV Table 2.1 Project B Scenario Summary Current Values: Changing Cells: $C$37-Discount Rate Result Cells: $D$37-NPV Table 2.2 New Values New Values

9.91% 8,25,133.16

7.52% 8,96,999.35

9.91% 6,86,153.22

7.52% 8,15,241.99

1,000,000.00 900,000.00 800,000.00 700,000.00 600,000.00 500,000.00 400,000.00 300,000.00 200,000.00 100,000.00 Discount Rate -9.91% Discount Rate -7.52% NPV(A) NPV(B)

Figure 2.1 Since, NPV is inversely proportional to discount rate, both NPVs have increased with decrease in discount rate. IRR remains the same for both projects. As NPV of Project A is higher than that of Project B, the companys investment decision doesnt change.

Answer 3)
There are three estimates for the rate of growth in expenses: Project Pessimistic Neutral Optimistic Table 3.1 A 6.75% 4% 1.25% B 5.1% 4% 2.4%

Excels Scenario Manager Tool was used to examine both projects in these three scenarios. Project A & B has been evaluated for three different estimates of rate of growth in expenses (ROG).

Change in rate of growth in expenses result in change in the following variables:1) Expenses 2) Profit before depreciation 3) Taxable Profit 4) Tax 5) Net Cash Flow 6) NPV 7) IRR The results obtained are as shown below:-

Project A Scenario Summary Current Values: Changing Cells: Discount Rate ROG Result Cells: IRR NPV Table 3.2 Pessismistic Neutral Optimistic

9.91% 4.00% 83.873%

9.91% 6.75% 74.047%

9.91% 4.00% 83.873%

9.91% 1.25% 92.160%

8,25,133.16 6,31,825.37 8,25,133.16 10,08,858.27

At ROG of 6.75% (68.75% higher than neutral estimate) IRR decreases by 11.71% from 83.873% to 74.047% and NPV decreases by 23.42% from 8,25,133.16 to 6,31,825.37.

At ROG of 1.25% (68.75% lower than neutral estimate) IRR increases by 9.88% from 83.873% to 92.16% and NPV increases by 22.26% from 8,25,133.16 to 10,08,858.27. Project B (Table 3.3) Scenario Summary Current Values: Changing Cells: Discount Rate ROG Result Cells: IRR NPV Pessimistic Neutral Optimistic

9.9100% 4% 28.987%

9.9100% 5% 26.723%

9.9100% 4% 28.987%

9.9100% 2% 32.049%

6,86,153.22 5,91,011.31 6,86,153.22 8,20,957.22

At ROG of 5.0% (25% higher than neutral estimate), IRR decreases by 7.81% from 28.987% to 26.723% and NPV decreases by 13.86% from 6,86,153.22 to 5,91,011.31. At ROG of 2% (50% lower than neutral estimate) IRR increases by 10.56% from 28.987% to 32.049% and NPV increases by 19.64% from 6,86,153.22 to 8,20,957.22. The companys investment decision doesnt change in these scenarios. This is because, the NPV and IRR of the Project A is still better than Project B in Pessimistic, Neutral and Optimistic Scenarios as shown graphically below.

1,200,000.00

1,000,000.00

800,000.00 NPV(A) NPV(B) 400,000.00

600,000.00

200,000.00

Pessimistic Neutral Optimistic

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Pessimistic Neutral Optimistic IRR(A) IRR(B)

Figures 3.1 & 3.2

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Answer 4)
I used the solver tool in excel to adjust initial price/unit, Initial Revenue (units), sales growth rate and rate of growth in expenses upto the constraints as shown below. The results obtained are as follows: Project A Target Cell (Value Of) Cell $D$38 Name NPV Year 0 Original Value 8,25,133.16 Final Value 30,00,000.00

Adjustments Cell $D$5 $D$8 $B$6 $B$5 Constraints Cell $E$6 $F$6 Name Sale Price/Unit Year 1 Sale Price/Unit Year 2 Cell Value 53.31 54.91 56.56 58.25 60.00 2% 2.25% Formula $E$6<=60 $F$6<=60 $G$6<=60 $H$6<=60 $I$6<=60 $D$5<=0.02 $D$8>=0.0225 Name Growth in Revenue(units) Growth in Expenses/unit Initial Price/unit Initial Revenue(units) Original Value -2% 4% 50.00 40,000.00 Final Value 2% 2.25% 53.31 79,667.00

$G$6 Sale Price/Unit Year 3 $H$6 Sale Price/Unit Year 4 $I$6 Sale Price/Unit Year 5

$D$5 Growth rate of Revenue (units) $D$8 Expenses/Unit Growth rate Table 4.1

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Sales required initially: Sales Units x unit price = 79,667 x 53.31 = 42,47,047.44 Project B Target Cell Cell $D$37 NPV Year 0 Name Original Value 6,86,153.22 Final Value 30,00,000.00

Adjustments Cell $B$4 $D$4 $D$7 $B$6 Constraints Cell $E$6 $F$6 $G$6 $H$6 $I$6 $D$4 $D$7 Table 4.2 Name Initial Revenue (units) Revenue (units) Rate of Growth Expenses/Unit Rate of Growth Initial Price Name Sale Price/Unit Year 1 Sale Price/Unit Year 2 Sale Price/Unit Year 3 Sale Price/Unit Year 4 Sale Price/Unit Year 5 Revenue (units) Rate of Growth Expenses/Unit Rate of Growth Original Value 7,000 8.00% 4.00% 275.00 Cell Value 263.98 271.90 280.06 288.46 297.11 8.25% 3.75% Final Value 22,325 8.25% 3.75% 263.98 Formula $E$6<=299.99 $F$6<=299.99 $G$6<=299.99 $H$6<=299.99 $I$6<=299.99 $D$4<=0.0825 $D$7>=0.0375

Sales required initially: Sales Units x unit price = 22,325 x 264 = 58,93,800.00 As can be observed, target NPV was achievable for both projects. The company should undertake Project A to achieve the target NPV of 30 million. This is because of the following two reasons:1) The initial revenue for Project A is more achievable than Project B. Project B being manufacture of telescopes for astronomers which is a high price, low sales volume product. Initial revenue of 7000 units for Project B adjusts to 22,325 units, an increase by 218% which may not be achievable. On the

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other hand, Project A involves manufacturing telescopes for children which are high sales volume products. Without significant increase in price/unit, sale of 79677 units against present 40000 units (99% higher) is possible by using existing advertising contracts. 2) Since NPV for both projects is same, I calculated IRR using the excel function after incorporating all the new values obtained from solver. IRR for Project A is 257.051% while IRR for Project B is 93.423%. As discussed previously, higher the IRR, better is the investment. Hence, the company should go with Project A.

Answer 5)
After evaluating both projects on several grounds of capital budgeting, scenario analysis and target NPV achievability, I have come to a conclusion that the directors should choose Project A.

Conclusion:
Capital Budgeting showed that NPV and IRR are higher for Project A. Scenario Analysis done by changing discount rate and expenses growth rate showed that Project A is a preferable investment. Finally I used the solver facility of excel to find whether NPV of 30 million is achievable. Although both projects could achieve the NPV by adjusting some variables, Project A has a higher IRR. All in all, Project A is better investment project and one can say that Excel provides valuable tools for analysing investments.

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Bibliography
R Brealey and S Myers, "Principles of Corporate Finance", 8th Ed., McGraw Hill, 2005.
D Hillier, D McDougall and A Marshall, Excel for Finance University of Strathclyde, 1995

Class Notes

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