The Firmino Project
An estimate of the current Weighted Average Cost of Capital (WACC) of the company
To find the WACC of the company the following equation should be used
(Saki et al., 2018):
WACC =D r d (1— Tc) + E re
V V
Where:
- D=Market value of bonds (N-umber of bonds x bond price)
- E = Market value of equity (Number of shares x share price)
- V = Total value of the firm (= D+E)
- rd= required return on bonds(the YTM on the bonds)
- re =required return on equity (use the CAPM)
- Tc = Corporate tax rate
Variable Estimates
Market value of equity (E)
E= 500m* 1.6 = 800
Market value of bonds (D)
=Price at Time = (10m)
Total value of the firm (= D+E)
800+10= 810
YTM on the bonds
P(T0) = [PMT(T1) / (1 + r)^1] + [PMT(T2) / (1 + r)^2] … [(PMT(Tn) + FV) / (1 + r)^n]
Where:
- P(T0) = Price at Time 0 (10m)
- PMT(Tn) = Coupon Payment at Time N (12% *100= 12)
- FV = Future Value, Par Value, Principal Value (100)
- R = Yield to Maturity, Market Interest Rates
- N = Number of Periods (5 yrs)
10m= [12/ (1+r)1 ] + [12/(1+r)2] + [12/ (1+r)3] + [12/ (1+r)4] + [12/ (1+r)5] + [100/ (1+r)5]
160 = 10,000,000
(1+r) 20
(10,000,000 + 10,000,000r)20 =160
10,000,000r= 252. 9822- 10,000,00/ 10,000,000
r= -0.999%
Required return on equity (use the CAPM)
Ra= Rrf+[Ba∗(Rm−Rrf)]
where:
- =PRa=Cost of Equity
Rrf=Risk-Free Rate
= Rate of yield on bond- current inflation rate
=1.96% – 4.7% = -2.74%
Ba=Beta
Beta= Covariance
Variance
where:
- Covariance=Measure of a stock’s return ((800-500)/500)* 100relative
to that of the market (1.0)
Compared to McDonalds stock’s return which is 6.52%
=((6-1) * (6.52)) 2-1
5*5.52= 26
- Variance=Measure of how the market moves relative
to its mean
Where:
- σ2 = population variance
- Σ = sum of…
- Χ = each value
- μ = population mean
- Ν = number of values in the population
= ( (6.52- 6)2) /2
=0.1352
Ba=Beta
= 26/ 0.1352 = 192.26
Rm=Market Rate of Return = -0.999%
Thus, Required return on equity =
Ra=Rrf+[Ba∗(Rm−Rrf)]
-2.74 + ( 192.26( 0.999-(-2.74)
RE =716.12
Tc = Corporate tax rate = 21%
Calculating WACC
WACC =D r d (1— Tc) + E re
V V
10 * -0.999% (1 – 0.21) +800 * 716
810 810
WACC= 7.074
A detailed cash flow forecast for the whole project (100 stores) per store
The Table 1 below contains a detailed cash flow forecast for the Firmino supermarket project for the first six years of operation. The table contains a statement of one store assuming that all the 100 stores have identical cash flows.
Firmino Project Cash Flow Statement Forecast
Table 1: Cash flow forecast
Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory
Explanation of Cash Flows
Shown in Table 1 above is the Firmino supermarket project cash flows for the first six years of operation. The table contains cash flows per store for six years. During the firt two years the project contains three cash injections from Manesalah plc in the sequences of 700 injected immediately, 550 at the end of the first year, and 400 at the end of the second year. The company needs to pay Dalglish Inc. for their consultancy services in three equal instalments. The first instalment has been paid, the second is paid in the first year, while the last instalment shall be paid after two years. These are the only cash flows for the project in the first two years.
In the third year, the project will be fully operational, hence, there will be an addition in the cash flows. The cash inflow has sales amount and cash injections which shall be added to get total cash receipts. The cast outflows has elements such as rent, cost of goods sold, staffing costs, power bills, telephone, insurance, tax, postage fees, legal fees, accountancy fees and cost of maintenance. Manesalah will not inject more cash into the project after the second year, thus most of the cash inflows will be generated from sales. On the third year each store is expected to have a 80m sales amount which will increase at 8% per year.
Moreover, on the cash outflow statement, each store is expected to have a rental fees of 25m per year which shall increase after the fourth year to 30m. The cost of producing goods shall be 50m at the third year but will increase by 7% per annum to the sixth year. The firm’s electricity bill will be 1m per year but may increase by 0.2m after the fourth year. In addition is the staffing costs that are forecasted at 15m during the third year and will increase by 10% every year. Tax fees are expected to by 10% of the sales revenues, therefore, as sales increase, tax fees increase and vice versa. Other cash out flows include insurance at 10m, legal fees at 8m up to year 4 and 10m from the fifth year onwards. The company’s advertising fees as per year 3 are 4m and will increase by 1m each year while the cost of maintenances will remain at 10m for the six years. The seventh year cash flows will be identical to year six and will continue to every year thereafter.
An appraisal of the project using appropriate techniques
There are several accounting techniques that can be applied to appraise an investment project. Some of these techniques include internal rate of return (IRR), accounting rate of return (ARR), payback period, and the net present value (NPV) (Marchioni & Magni, 2018). For this project, the profitability index, and net profit value. The project will avoid using the payback period appraisal technique as it does not consider the time value for money and if the project will still be profitable after paying back its initial investment.
Profitability Index
A profitability index establishes how much each coin invested in a project earns. A positive profitability index reveals that the project is a profitable investment while the vice versa is true (Mari & Marra, 2019).
Profitability index (PI)= anticipated future cash flow
Initial cash outflow
=4708.56/ 2660= 1.7701
The profitability index of Firmino project is 1.77
Net Present Value
NPV = Cash flow / (1 + i)^t – initial investment
In this case,
i = required return or discount rate
t = number of time periods.
For the Firmino supermarket project, we shall assume the cash discounted rate to be 10%
= (4708.56/ (1+0.1)6 – 1650) 100
= 10.07
Recommendation
In reference to the financial investment appraisal technique, the Firmino project is profitable, hence, Manesalah plc should invest in it. According to the profitability index (PI), the project has a profit of 1.7 per every euro invested. When using NPV, a percentage higher than 1 shows the profitability of a project while a result less than one reveals a project’s failure (Wang & Yu, 2021). In this case, the NPV results were 10% meaning Manesalah should pursue it as it is highly profitable.
An estimate of the expected NPV, the standard deviation of the NPV, a recommendation
The NPV in this section is borrowed from the previous
The expected NPV, the standard deviation of the NPV
Table 2: the expected NPV and the standard deviation of the NPV
NPV = Cash flow / (1 + i)^t – initial investment
In this case,
i = required return or discount rate
t = number of time periods.
(4708.56 * 100/ (1+0.1)6 – 1650)/ 100
= 2.641
Recommendation
A standard deviation shows how far or closely distributed figures are from the mean. A high standard deviation shows that the figures are far dispersed from the mean while a low standard deviation shows that numbers are closely knitted around the mean. A high standard deviation of the NPV shows that it is unrealizable because it keeps on changing. In the case of the Firmino Supermarket project, the NPV is closely distributed when the number of stores is high. Hence, the higher the number of stores, the more reliable the project is. Meaning, Manesalah should invest in the maximum number of stores to have a reliable return.
References
Marchioni, A., & Magni, C. A. (2018). Investment decisions and sensitivity analysis: NPV-consistency of rates of return. European Journal of Operational Research, 268(1), 361-372. Web.
Mari, C., & Marra, M. (2019). Valuing firm’s financial flexibility under default risk and bankruptcy costs: a WACC based approach. International Journal of Managerial Finance. Web.
Saki, N., Maghari, A. E., & Mahtab Arab, R. H. (2018). The Relationship of Net Asset Growth and Profitability Index with Stock Returns Evidence from Tehran Stock Exchange. Pacific Business Review International, 10(10), 57-65. Web.
Wang, C. J., & Yu, M. (2021). The Informativeness of Analysts’ Cash Flow Forecasts: International Evidence. Wang, C., and M. Yu, 70-91. Web.
Appendix
Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory
Cost of Goods Sold
Appendix 1: Cost of Goods Sold
The expected NPV, the standard deviation of the NPV
Appendix2: The expected NPV, the standard deviation of the NPV