Your submission should be a 3-page executive summary of what you found in your analysis with two external citations and a copy of the Microsoft Excel spreadsheet that you used to complete your analysis
Part 1
Your submission should be a 3-page executive summary of what you found in your analysis with two external citations and a copy of the Microsoft Excel spreadsheet that you used to complete your analysis. Graphs and figures should be presented as appendices (i.e. not presented within the body of the executive summary).
You have just been hired by Internal Business Machines Corporation (IBM) in their capital budgeting division. Your first assignment is to determine the free cash flows and NPV of a proposed new type of tablet computer similar in size to an iPad but with the operating power of a high-end desktop system.
Note: Use ‘Table 8.3’ on page 247 as a guide to set up your FCF estimates.
Point 1: Development of the new system will initially require an initial capital expenditure equal to 10% of IBM’s Net Property, Plant, and Equipment (PPE) at the end of the latest fiscal year for which data is available in 2019 or data from 12/31/2019.
Ignore: The project will then require an additional investment in the first year equal to one half the initial investment.
Point 2: The product is expected to have a life of five years.
Point 3: First-year revenues for the new product are expected to be 3% of IBM’s total revenue for the latest fiscal year using fiscal year 2019 or data from 12/31/2019.
Point 4: The new product’s revenues are expected to grow at 15% for the second year then 10% for the third and 5% annually for the final two years of the expected life of the project.
Your job is to determine the rest of the cash flows associated with this project. Your boss has indicated that the operating costs and net working capital requirements are similar to the rest of the company (implying the project will have the same ratio of EBITDA to sales and working capital to sales) and that depreciation is straight-line (over 5 years) for capital budgeting purposes. Since your boss hasn’t been much help (welcome to the “real world”!), here are some tips to guide your analysis:
Point 5: Obtain IBM’s financial statements. (If you really worked for IBM you would already have this data, but at least you won’t get fired if your analysis is off target.) Download the annual income statements, balance sheets, and cash flow statements for the last four fiscal years from Yahoo! Finance (finance.yahoo.com). Enter IBM’s ticker symbol and then go to “financials.” Use the data from the spreadsheet that I have provided.
Point 6: Determine the annual depreciation by assuming IBM depreciates these assets by the straight-line method over a five-year life (i.e., depreciate the ‘cost of the new system’ in Point 1).
Point 7: Determine IBM’s tax rate by using the current U.S. federal corporate income tax rate (Use an estimated 21% for the corporate tax rate).
Point 8: Calculate the net working capital required each year by assuming that the level of NWC will be a constant percentage of the project’s sales. Use IBM’s NWC/Sales for the latest fiscal year to estimate the required percentage. (Use only accounts receivable, accounts payable, and inventory to measure working capital. Other components of current assets and liabilities are harder to interpret and not necessarily reflective of the project’s required NWC—for example, IBM’s cash holdings.) In year 1, you are going to increase NWC using the NWC / Sales ratio for IBM in 12/31/2019 using only A/R, A/P, and inventory to measure NWC (use Table 8.3 and 8.4 as a guide for how to bring the increase in NWC into your FCF estimate in year one and take it back out in year 5—for simplicity purposes we are going to assume that NWC remains fixed in years 2 through 4 and then it is recaptured in year 5).
Point 9: To determine the free cash flow, deduct the additional capital investment and the change in net working capital each year (note: using information from Point 8, the NWC will only change in years 1 and 5—see Table 8.3 line item 12 and Table 8.4 as an example).
Point 10: Use Excel to determine the NPV of the project with a 12% cost of capital. Also calculate the IRR of the project using Excel’s IRR function.
Point 11: Perform a sensitivity analysis by varying the project forecasts as follows:
a. Suppose first year sales will equal 2%–4% of IBM’s revenues.
b. Suppose the cost of capital is 10%–15%.
c. Suppose revenue growth is constant after the first year at a rate of 0%–10%
Part 2(a)
Must be between 300-500 words. Use in text citations and use websites that are based in the United States and should be at least 2 references. Discussion post responses
Harris and Raviv stated, Details of the capital budgeting procedure seem to be critical in determining actual capital allocations. Decisions are often delegated throughout an organization. The capital budgeting process governs the way in which managers are various levels produce and share information about proposed investments and determines which decisions are delegated, to whom, and under what constraints. In firms individual managers or divisions are assigned capital spending limits, sometimes based on proposals generated by the managers, but this can result in passing up projects with positive NPV. Other issues that may not be addressed to the full extent in the capital budgeting model is at what level would one expect capital spending limits to apply, and would it be at the project or business level. When dealing with the capital budgeting model the variable of the capital allocation process and managerial compensation schemes can have a negative impact. We have all read about companies who have had fraud because of this reason, it can bring a company to its knees it managers are asking for capital allocation that is not needed and potentially ignoring the projects with a positive NPV.
Cisco Senior vice President David Hooland expresses why their company uses NPV to make investment decision; Robust NPV analysis goes beyond simply accepting projects with positive NPV’s and rejecting those with negative NPV’s. It identifies the key drivers that affect project success and demonstrates the interplay between factors that affect cash flow. Net present value is the “golden rule” of financial decision making. The NPV of a project or investment as the difference between the present value and its benefits and the present value of its cost, it shows all project cash flows. (Berk, 2020. Pp. 72). Other processes can be used in conjunction with NPV and compared to one another but as of now I do not know of another process that would work more efficiently than NPV.
Berk, J. B., & DeMarzo, P. M. (2019). Corporate finance: The Core (5th ed.). Boston, MA: Pearson. ISBN: 9780135161159
Harris, M., Raviv, A. 1996. The Capital Budgeting Process: Incentives and Information. Journal of Finance. Vol. 21. No. 4 (pp.1139-1774). Wiley. Doi: 10.2307/2329390. https://www.jstor.org/stable/2329390
Part 2(b)
Must be between 300-500 words. Use in text citations and use websites that are based in the United States and should be at least 2 references. Discussion post responses.
Capital budgeting is the process in which financial managers analyze one or two projects or even multiples projects to determinate and make risk decisions about the best project that has a positive net present value (NPV). In other words, firms accept projects that present the best opportunities of cash flows that is related with the firm’s missions and objective goals. Why capital budgeting process is important for firm before making-decisions to undertake a project?
According to Alonso and Matouschek (2007, pg. 1070), an understanding of what determines the internal allocation of decision right is … a prerequisite for understanding, and potentially being able to predict, the decisions that firms make, such as how much to invest. The decision for CEO and CFO to invest in a new project is subject to the following key words: revenue related to cost of the project, break-Even analysis, internal rate of return, incremental cash flows and lastly the maximum NPV. The NPV rule stated that we should compare the project’s NPV to zero (the NPV of doing nothing) and accept the project if its NPV is positive (Berk & DeMarzo, 2020). It is important for companies to analyze new project revenue against its costs while establishing the project to decide if it will benefit the company in the best ability generating incremental cash flows. With the capital budgeting process, financial managers should make the best decision that maximize NPV while analyzing the break-even quantity of products that allow company to break-even (no profit and no lost occurred). In a 2001 study, 75% of the firms surveyed used the NPV rule for making investment decisions (Graham & Harvey, 2001). Internal rate of return is another tool to analyze investment making-decisions. The focus on the internal rate of return allows us to maximize error in the cost of capital where the NPV of the project depends on its appropriate cost of capital. The internal rate of return measures the average return over the life of an investment and indicates the sensitivity of the NPV to estimation error in the cost of capital (Berk & DeMarzo, 2020, Pg. 223). Is it another process making capital allocation decisions?
Yes, it is the delegation of decision-making process in firms. There are three levels of workforce, top-level as executive members, middle-level employees such as supervisors and lower-level employees like front line workers. We can affirm that the degree of the delegation of making-decision process is not the same across all companies. CEOs are more likely to make decisions without taking input from others due to their status in the organization. This dominant role of CEOs in acquisitions is consistent with who argue that the acquisition decision should not be delegated to lower-level managers (Harris and Raviv, 2005). The delegation of decision-making process is neither important than capital budgeting process because both processes final goals is to maximize objective goals and missions of the organization. The delegation of decision-making process is not monolithic but varied due to individuals making decisions and not simply by corporate entities. Delegation decisions are affected by the company characteristics and interactions where human element is strong to the delegation of investment funds with capital allocation. Without delegation of decisions-making process, who can we improve the capital budgeting? The net present value, CEOs rely heavily on informal allocation rules, which reveal a human element, related to divisional manager’s reputation with the timing of when cash flows are produced by a project, while senior management’s gut feel (Graham et al., 2015).
References
Alonzo, R. and Matouschek, N. (2007). Relational delegation. RAND Journal of Economics 38 (4), pg. 1070-1089
Berk, J. B. & DeMarzo P. M. (2020). Corporate finance: The Core (5th ed.). Pearson.
Graham, J., and Harvey, C. (2001). The Theory and Practice of Corporate Finance: Evidence from the Field,” Journal of Financial Economics 60: pg.187–243.
Graham, J., Harvey, C., and Puri, M. (2015). Capital allocation and delegation of decision-making authority within firms. Journal of Financial Economics, 115, 449-470.
Harris, M., and Raviv, A. (2005). Allocation of decision-making authority. Review of Finance 9, 353-383.
Part 1 is attachment completely. It needs to be examined. Remember in part 1 please remember to include the excell functions and calculations. Of course part 2 needs to be completely done.
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