International Financial Management for Business Assessment Answer

How Does Aromatic Chemicals Evaluate Its Capital-Expenditure Proposals? Why Such a Complicated Scheme Is Used for Evaluation of Proposals? Suggest Simplification of This Scheme Providing Your Rationale.

Capital expenditure refers to the expense of a company when it wants to acquire, upgrade and maintain a company with its tangible assets- land, machines, plants, buildings, patents, trademarks, etc. Managers and analysts try to maximize the market value of an organization by reaching the optimum value of capital expenditure McConnell, 1985 Aromatic Chemicals evaluate its capital-expenditure proposals with four criteria:

1. New product or market,
2. Product or market extension,
3. Engineering efficiency,
4. Safety or environment.

The project's founders review these stages in order to get senior management's approval. Before the concept can proceed, at least three of the aforementioned conditions must be satisfied.

Aromatic Chemical's capital expenditure guideline advised employing double-declining-balance (DDB) depreciation, despite the tax code's stricter enabling such practises. This tactic was utilised to avoid asking for business approvals based on tax laws, which might not apply uniformly to all projects and divisions. Before getting the go-ahead from senior management, the controller's staff would unbiasedly assess any pertinent tax repercussions. Division managers were advised not to emphasise those consequences too much, though. The first ten years of a 15-year project's depreciation were computed using the DDB method and the accelerated depreciation method. To ensure that the resource degraded fully over its financial life, it was standard practise to switch totally to a straight line. In the part that follows, I'll go over a variety of methods for assessing project proposals.

EPS (profit per share)

Engineering projects must contribute to a positive net profit. The EPS of a project is determined by averaging its EPS over the course of its lengthy economic life. In this case, the annual free cash flow is divided by the number of issued shares to obtain the profit per share (based on 200,891,240 shares). This is an evaluation strategy, but it is dubious because it ignores the fundamental hypothesis, which is the most important aspect of the project. Because EPS is essentially profit, this technique also has the drawback of being depending on account norms. The decision will be based on issued shares. In our situation, the project's EPS is based on free cash flow, which addresses some of the concerns.

Payback method

"Payback" is the period of time needed to recover the initial investment. For the third group of activities, the compensation period should last six years. This strategy, in my opinion, is not a good one for project evaluation. To start, even though our project will be finished in 15 years, the payback period will only be 6. So, neither the inflow of funds nor the nine years that followed will be taken into consideration. The Not Discounted Free Cash Flow is usually computed using this method without taking into account the time value of money, which is another disadvantage. Calculating the payback period using discounted cash flow will fix this.

DCF analysis (discounted cash flow)

The most accurate method for project evaluation is the DCF analysis, often known as NPV (net present value). There are, however, a few key distinctions between NPV and DCF: In contrast to NPV, which is concerned with future expenses, DCF is a present investment in a desired future outcome (Leybag and Leybag, 2021). By deducting the initial investment from the hurdle rate of 12% and accounting for inflation at 3%, the discounted cash flow, or DCF, is calculated. For the project to be approved, the DCF value must be positive. All computations and evaluations in our example are based on the DCF methodology, the most used project evaluation technique. This approach will produce the optimum outcomes for the project, depending on how precisely the discount rate is computed. In contrast to other methods, it considers elements like the initial investment, the worth of money over time, the rate of inflation, and other considerations. The Internal Rate of Return (IRR) is the last but not least: It is important to examine the hurdle rate and internal rate of return (IRR) for the project. In this case, the IRR of the third category project must be higher than 12%. hurdle rate). There are factors to think about. Results from IRR and NPV studies are consistent. IRR is higher than the hurdle rate if NPV is larger than zero, and vice versa.Out of all the above mentioned methods, I reckon using DCF analysis is the most reliable way to evaluate a new project. Along with finding the NPV value, the same conclusion can be drawn for the IRR. The company should also use market data and software to simplify the proposal evaluation process. With data science technology, Aromatic will find data about new products, markets, product extensions, and competitors

Evaluate the Transport Division's Suggestion? Does it have any Merit?

Propylene gas was delivered to Merseyside by a tank car run by Aromatic Chemicals from four UK oil refineries. Tank vehicles were under the authority of the expenditure community for transportation, which was also in charge of overseeing the production of all raw materials, intermediate materials, and finished goods within the association. The transportation provider will need to send extra tank cars to Merseyside due to the project's higher throughput. The situation grew more urgent. The price of the purchase is £20 million. The company's expected expansion into more markets from 2022 to 2020 is made possible by the transportation sector's ability to allocate this resource from excess capacity. The Transport Division thus recommended that the price of the tank vehicles be covered by the initial investment for Merseyside's construction programme. If Merseyside is excluded from their revenue, then their argument is invalid. Nonetheless, their approach provides benefits for the expansion of the business.

Evaluate the Director of Sales' Suggestion? Does it have Any Merit?

The director of sales indicated that despite the fierce competition in the polypropylene market, Aromatic would be able to sell the excess output and therefore realise the project's total efficiency. A surplus appears likely given the industry's ongoing decline. In order to convey the extra goods, the firm will presumably need to shift its capacity from Rotterdam to Merseyside. Is there an increase in the use of aromatic chemicals? Why was funding given to a plant that obliterates other plants? When a new product from the same company lowers sales volume or market share, cannibalism happens. The demand for the current product will eventually be "eaten up" by the new invention, leading to lower overall sales. Product sales volume and market share are negatively impacted by this downward pressure (Corporate Cannibalism Definition, 2021). Notwithstanding the purchase of a competitor company, a product with a diminishing consumer base runs the risk of slipping into deficit. As a result, after an acquisition, corporate cannibalism does not lead to an increase in total sales. He sees some value in the Sales Director. If the business pursues a merger or acquisition in a volatile market, it is at risk. If Aromatic is making a profit that is much higher than Merseyside's, the parent company's finances will suffer because to an excess stock of the product (double or triple).

Why Did the Assistant Plant Manager Offer his Suggested Change? Does it have Any Merit?

Harry, the assistant plant manager, made changes to David's analysis. To the independent Merseyside plant unit that produces ethylene-propylene-copolymer rubber, he has proposed changes (EPC). In the latter part of the 1980s, Fragrant Synthetic Substances produced a variety of engineered rubbers and supplied several of them to European tyre manufacturers. EPC has remained a very tiny product in the European chemical sector, contrary to hopes that this oxidation-resistant rubber would dominate the plastics market. Aromatic, the main supplier to EPC, made everything in Merseyside. For Aromatic, EPC has generated a modest profit during the previous five years. Harry suggested revamping the EPC production line for 10 million pounds. With this renovation, Sweet-smelling will witness a £ 250,000 increase in revenue and the lowest EPC cost base in the entire world. However, the amount and current price were used to calculate the project's net present value (NPV). £ 2,500,000. Harry also advised including the EPC project into the renovation of the polypropylene line. Positive NPV of poly repair can essentially keep up with negative NPV of an EPC project. This action was proposed by the assistant plant manager in order to protect the business from the acquisition and reinvestments.

EPC rubber is not only flexible but also ozone and electrical resistant (ethylene-propylene copolymer chemical compound, 2021). Because to its qualities, EPCs are frequently utilised in the building, electrical wiring, and automotive industries (ethylene-propylene copolymer chemical compound, 2021). Due to the high speed of technological advancement, the market for EPC has enormous potential. The need for synthetic rubber-like EPC is rapidly increasing as automation and customised cars become more common. As a result, the assistant plant manager gave a great suggestion for the growth and survival of the business.

What Did the Analyst from the Treasury Staff Mean by His Comment About Inflation? Do You Agree with It?

When establishing assumptions regarding inflation, Wilson Andrews of Aromatic Chemistry's treasury department explained that cash flow and discount rates must be consistent because this factor directly affects the DCF. The nominal target rate of return for the analysis is the 12 current hurdle rate.

Actual inflation and nominal inflation are the two key variables. The relationship between the nominal, real, and inflation rates is shown by Fisher's equation. The Fisher's equation is as follows: In this equation, "I" stands for the nominal interest rate, "r" for the real interest rate, and "" for the rate of inflation Fisher Equation, 2021). For instance, according to Treasury officials, the long-term inflation expectation is 3 present per year, and the nominal inflation rate is the 12 present hurdle rate. The future cash flow should be used to adjust the inflation rate. The actual (inflation-free) objective rate of return for Aromatic Chemicals is 9. As a result, at the project-wide discount rate, 12 will always be present.

Throughout the coming years, product prices will rise by 3% yearly, and new sales can be computed using output and prices (which will rise by 3% annually). When gross profit is used to determine cash flow, costs also account for growing inflation. I concur with the Treasury staff's interpretation as a result, and I'll use a modified Excel graphic to elaborate on my point.

Explain the Difference Between the Free Cash Flows and the Equity Cash Flows Mentioned by the Senior Analyst of Treasury.

Profitability in terms of net income was a prerequisite for engineering efficiency projects. We divided the overall economic benefit of the project during its whole economic life by the number of outstanding shares as of the end of the most recent fiscal year to get the average yearly EPS contribution of the project over its entire economic life (FYE).

Personally, I'd use tools like internal rate of return and net present value to evaluate the venture and come to the conclusion that "There is benefit in pursuing this enterprise." Since greater values have been realised as a result of improved output and sales, the NPV without cannibalization is also computed as part of the research. In this case, the project has an NPV of £10,400,000 and an IRR of 30.02 percent. Earnings per share are greater than those of the cannibalization programme, and the payback period is only 3.85 years. So, it is important to look at the task from both perspectives, including the potential for human flesh consumption.

The benefits of at least one free element limit the applicability of this method. The attached Excel file displays the sensitivity analysis that was performed using project data with and without cannibal. Robert was cut off before he could finish thinking about Oscar's remark. The sales staff is worried that the approach will fail because of excess capacity. After reviewing the current version of the capital planning guideline for Sweet-smelling Synthetics, Robert has chosen to implement the markdown rate of 12%.

Calculate the Cost of Capital for the Liverpool Project Using Weighted Average Cost of Capital of Debt and Equity and Also Confirming with Your Own Calculations That the Cost of Equity Capital for Aromatic Chemicals Is Indeed 12% as Stated by the Senior Analyst of Treasury

Capital structure:

% of debt in total financing

D = market value of debt; E = market value of equity

D=275; E=25.52

% of equity in total financing

D = market value of debt; E = market value of equity

D=275;E=25.52

Weighted average cost of Capital

WACC(

How should Robert modify his DCF analysis?

The DCF (discounted cash flow) calculation, which considers factors including sales, profit margin, pricing, annual output, and depreciation, is used to determine a company's value. Davis' DCF fell short since it only provided data going back six years. It is simpler to assess the parameters and the company's future with this 15-year DCF chart. The updated DCF indicates that after ten years (in 2030), the cash flow starts to fall and doesn't rise again for five years. After the fourth year, earnings per share (EPS) likewise gradually decreases. These changes need to be made by David.

Engineering

Efficiency While deciding between two projects or one project over another, an analyst should take the added expense into account. The crucial choice in the current situation is whether to embark on a polypropylene project. Engineering fees for the renovation's efficiency and design studies have cost five million pounds over the last nine months. Sunk costs are expenses that have already been paid for but are not continuing to rise. does not change whether Applied Chemicals will take over the project. In the DCF analysis, the cost of pre-construction is zero.

Overhead Cost

 The cost of the item is frequently recalled as the overall expense of the processing plant, which is communicated across the assembly line. In this case, overhead costs are equal to 3.5% of the book value of the project's purchased assets. One question is all that matters. Are these expenses recent? If the business declines the projects, will the y equal 0? No, that's the response. The total overhead can be considered for estimating long-term cash flows rather than incremental cash flows because it will remain constant or nearly constant. Comparably, a DCF inquiry would cost $0 for the above assignment.

Cost of Goods/WIP Inventory

Cannibalisation of the Rotterdam plan

 (Definition of "Work in Progress (WIP)", 2021) Work in progress (WIP) inventory refers to the price of labour, skill, and raw materials used to manufacture a good or product. The DCF analysis heavily relies on WIP adjustments. Only the first two years' worth of inventory variations were considered in David's analysis. This is so because the analysis only considers the first two years' worth of item pay. The work-in-process inventory value should be calculated as 3% of the cost of the goods sold annually because sales and gross profit vary from year to year and inflation affects the model.

Inflation

Investment and capital flow are impacted by inflation. In a DCF analysis, capital flow adjustments are made. In the transportation industry, inflation influences whether a tank vehicle costs 20 (1 + 0.03) 3 or 20 (1 + 0.03) 5. Prices are impacted by both capital movements and inflation. As a result, there is a 3% variation in the product's annual sales and gross profit.

Cannibalism

 DCF study requires cannibalism at other sites (like the Rotterdam factory). This fact causes deals and results to be significantly altered, and free revenue as a whole is reduced. Notwithstanding the fact that there were 2,500,000 units sold overall, a decline in sales will have an impact on how inventory fluctuations are computed. The WIP number in the graph shows that even though sales volume will stay the same the following year, costs will go down.

Evaluate the Liverpool Project Worth to Aromatic Chemicals with and Without Cannibalism?

Without cannablism (using NPV and IRR)

The annual output of polypropylene pellets in Liverpool is currently at 3.5 million metric tonnes. In Aromatic Chemicals' present product mix, a tonne of polypropylene costs around £1,300. In order to determine the cost of capital, a 25% tax rate was applied. Robert discovered that the developing plant's framework was now worthless. Depreciation on new assets can be sped up during their predicted 15-year life period. As a one-time measure, the enhanced output would necessitate a rise in work-in-process inventory of 4% of the cost of goods. In the first year of his estimate for preliminary engineering, Robert factored in the £16,000,000 that had already been spent on efficiency and design studies of the renovation over the preceding nine months. Finally, the company manual states that 4% of the book value of assets gained through the project should be allocated annually for overhead expenditures when evaluating projects.

With cannablism (using NPV and IRR)

Limit needs to be shifted from Rotterdam to Liverpool in anticipation of potential increases in cargo traffic. Is this actually beneficial to aromatic substances? Spending money to have one plant eat another seems wasteful. The Vice President of Marketing seemed to be in a better mood. He anticipated that Aromatic Chemicals would be victorious against Saone-Poulet and Vaysol because of Liverpool's improved manufacturing efficiency. Competition to retain consumers will be strong in the current economic conditions, but the market will rebound and the company's lost volume should be made up for then. Robert considered the director's and vice president's points of view when he first evaluated the Liverpool project, and he concluded that no consideration of Rotterdam's prospective loss of business was necessary. He told Laura that cannibalism isn't a source of income. In this case, no serious evaluation is undertaken. In addition, we will never be able to keep our rates as low if the corporation begins to restrict its efforts to cut expenses by collecting fake fees like these. There should be no cost associated with being destroyed.

Examine the Sensitivity of the Project to Changes in the Manufacturing Throughput, Discount Rate and Gross Margin with Cannibalism

Sensitivity analysis examines how shifts in the independent input variable under various assumptions impact the values of the dependent variable (Sensitivity Analysis, 2021). In other words, sensitivity analysis investigates the relationship between different parts of a mathematical model's uncertainty and the model's overall level of uncertainty. This procedure is applied inside the bounds defined by one or more input variables. You can perform a sensitivity analysis for this situation with or without project data..

Assess the Impact of the Project on the Earnings Per Share of the Company and Explain How Eps- Ebit Analysis Helps in Deciding the Financial Policy of a Company

Merseyside is an initiative to improve the effectiveness of engineering. The predicted project's income contribution must be positive for engineering efficiency projects. This benchmark was established from the number of issued shares at the end of the fiscal year (FYE). Throughout the whole economic cycle, it shows the typical EPS contribution to a project. The issued share count for Aromatic Chemicals as of the year 2020 is 150,891,200. Earnings per share (EPS) for Aromatic are expected to have grown over time, averaging 14.93 pence at the time it acquired Merseyside. It is clear from the fact that even the lowest EPS is higher than the EPS in year one that the consolidation would increase the organization's EPS.

You Might Also Like:- 

Financial Accounting Assignment Help

ECON1020 Assessment Answer | COVID-19 Crisis | Financial Hardship for Jordan's Employer