Introduction
The purpose of this group assignment is to work together to complete analysis of the academic topics on financial management, as learnt from the first to the ninth week. The first key finding from this work is that the unit’s contents are essential for managers and other company staff involved with planning and budgeting. Secondly, ASX listing benefits both the subscribers and their customers.
Lastly, capital budgeting, risk analysis, and project evaluation processes demand sound understanding of applicable tools and techniques. The assignment is divided into three sections. Part 1 is a reflective journal that focuses on specific topics from the unit while Part 2 examines Australia’s securities markets. The last part covers the identification and application of capital budgeting tools in risk analysis and project evaluation.
Part 1 Reflective journal of a selected topic
Question 1: The financial concepts learnt in the session
One of the financial concept leant from the session is that coupon rate, maturity date, and current price are essential factors to consider when calculating the bond share value(Beadnok 2022).That is, to understand bond valuation, one must be aware of these three features of a regular bond. Coupon rate refers to the fixed return earned by an investor, periodically, up to the time when the bond matures. When the bond finally matures, investor receives the complete face value from bond issuer. Lastly, investor’s decision to purchase bonds at, above or below par is determined by the interest rate level within the given environment.
Secondly, the session brought forth the understanding that there exists six relevant capital budgeting methods that help companies to evaluate investment opportunities before deciding on whether or not to undertake a given project. The approaches include net present value (NPV), internal rate of return (IRR), simple payback period, equivalent annual cost (EAC), profitability index (PI), and discounted payback period (Beadnok 2022).Additional knowledge from the session is that each of these techniques may only be used to evaluate investment options with specific features.In other words, the useful life, mutual exclusivity, and similarities or differences in amounts of cash inflows (outflows) determine the capital budgeting technique that evaluators decide to use.
Question 2: The important issues regarding the financial concepts/formulas/calculations/skills/techniques, learnt in that session
On bonds share value calculation, the lecture emphasised that we must not forget the relationship between bond value and required rate of return as well as coupon rate.In particular, the lecture reminded us that an inverse relationship exists between bond value and required rate of return and that bond value relates positively to rate of coupon (Beadnok 2022).To confirm if the bond value calculation has been done correctly, the lecturer instructed us to ensure that bond value is greater than its face value in circumstances where coupon rate exceeds the required rate of return.
Next, to decide on the appropriate capital budgeting tool to apply when evaluating the options within a proposed project, Beadnok (2022)stated that specific factors must be considered. In other words, PI and NPV apply to independent and mutually exclusive projects, EAC is relevant when projects that generate same revenue have different useful lives, while IRR are best fit when cash flow amounts change from year to year. Again, payback period (simple or discounted) may only be considered in cases where options with varying useful lives have same amount of initial outlay. Additionally, when using IRR, PI, EAC,and payback period NPV is usually derived first before further calculations can be completed.
Question 3: Practice questions done in the class with the lecturer
Several practice questions were done in class and contents of three of those are discussed here.The first question involved calculation of NPV of two mutually exclusive projects. The options had equal useful life length (4 years) but the cash flows differed. When calculating the NPV, the lecturer explained that initial outlay should be a negative value so that after adding the rest of the cash flows (divided by one plus the discount rate, raised to appropriate year number) should help to determine whether or not the project is work investing into. At first we had trouble deciding if NPV or a different technique was appropriate for solving the question given that the options showed changes in cash flow and were mutually exclusive.
The second question covered calculation of EAC. The project in question had two options with similar revenue generation capacity but different useful lives. Additionally, the each option had same amount of annual cost from one year to the next. The first option had useful life of four years and the other one had five years.To get the EAC values, we had to calculate NPV then divide it by an equation constructed using the interest rate. The problem faced in this situation was with interpretation of the results. At first, it was difficult to understand why we had to choose the lowest value in EAC given that a higher value was selected when using NPV (especially because NPV was involved).However, we later came to understand that the lowest value in EAC meant that the chosen project was the cost-efficient one or one that involved lower costs of operation and maintenance.
Lastly, the third question involved scenario analysis. Main values provided in the question were the annual sales, average er unit sale price, initial cost, residual value, required working capital (to be recovered by the end of the project, 5 years), variable cost per unit, yearly cash fixed cost, tax percentage, and discount rate. The question also narrated the best and worst cases and gave the changes in various values as caused by each situation. The question looked very difficult and we were unable to begin solving it without the lecturer’s guidance. We later learned that we needed to calculate key items in base, best, and worse cases then compare the resulting NPV per case to decide if the investment was worth considering. The lecturers explained that a negative worst case NPV would mean that the project was risky.
Question 4: How to apply class work lesson in your real life
The knowledge gained in class is essential for planning process, where it helps to determine if a long-term investment that a company pursues had the potential to increase value for shareholders and generate profits. This knowledge applies to evaluation of several investments including machinery replacement,research and development projects, construction of a plant or launching of new products. The class work also involved use of different capital budgeting techniques that apply to projects with various features. As such, it will be easy to know the correct project evaluation tool to use based on the situations at hand.
Part 2: Fact finding of securities market in Australia.
The section contains responses to questions assigned to Group B
Task 1: Four reasons for being listed on ASX?
The reasons include:
1. Access enhanced liquidity and capital. ASX grants listed companies access to its large pension pool, which is projected to reach $9 trillion by the onset of 2040s (ASX Listings 2022).
2. Attain global reach.ASX offers investors a potential to achieve global recognition index (ASX Listings 2022.), even if the business is still in its early stage. Listed participants become get the chance to utilise capital 10 best international capital exchange.
3. Join a dedicated support program.ASX funds and lists both mature companies and those in their early growth stages.As a support program, ASX enables companies to reach investors.
4. Become part of a regulatory environment that is robust. ASX consists of more than 2,000 companies that belong to different geographies and sectors (ASX Listings 2022). Additionally, ASX is a leader in both technological innovation and trading infrastructure.
Task 2:
(1) Reasons for borrowing and lending securities
The most common reasons for borrowing and lending securities in Australian equities market are as follows (ASIX Participants 2022):
l A broker or custodian can borrow securities settle its obligations and stay away from penalties due to incurring repayment fail. This strategy works best for brokers or custodians whose obligations are due but lack the necessary securities because they faced operational challenges or the responsible client did nor arrange for delivery of the securities.
l A trader could also borrow after selling the securities short, to meet settlement obligations required by the settlement system for securities.In other words,a seller must possess an equivalent amount of securities it intends to transfer to a buyer (within three days of trade) in Australia.
l As a hedging strategy. If market-makers decide to hedge derivatives position that is equity-linked by selling securities that they do not own, they have to borrow securities to settle obligations.
l A trader could sell short when faced with an offsetting derivatives situation to benefit from cash and derivatives markets dislocation.
l A trader may also lend raise cash and fulfil funding needs.
(2) The contents of daily market report of outstanding loaned positions, by security:
An evaluation of whether or not a security’s outstanding loaned position will be equivalent to its short interest. Currently, the report states that this situation is unlikely. That is, borrowing securities to secure a short-sold state in security is more connected to arbitrage and hedging than an activity of directional short-selling (ASIX Participants 2022). Moreover, short-selling shares no association with finance-driven lending or borrowing caused by fails.
Task 3: Ongoing obligations as a registered company auditor
Auditors have ongoing obligations according to ASIC (2022) include to:
l Keep updated information about themselves
l Lodge reports like annual and financial statements and reports, within a month after the company’s anniversary
l Maintain their independence through identification of situations where conflict of interest occurs, and adhering to guidance on auditor rotation
l Follow recommended auditing standards to ensure audit quality
l Publish reports on audit transparency
l Comply with relevant registration conditions
l Report all solvency or contraventions problems while working at a company
l Adhere to terms of both the 2009 National Consumer Credit Protection Act and the 2001 Corporations Act
l Report to ASIC suspected and detected contraventions of the 2001 Corporations Act while serving as an auditor
Task 4: How can the ePayments Code protect you in banking?
ePayments Code does the following ASIC Regulatory Resources (2022):
l ePayments Code regulates Australia’s electronic payment.Here the Code serves as an addition to the regulatory guidelines under the National Consumer Credit Protection Act 2009 and the Corporations Act 2001. The Code complements the two Acts through its focus on disclosure obligations, and licensing of customer credit and financial services.
l Enables customers to confirm if the payment or banking services organisation is safe for them by directing them to the details they should check. In particular, checking through subscribers list and the terms and conditions of a company helps customers to confirm subscription to ePayments code.
l The Code encourages transparency by directing subscribers to ensure terms and conditions presented to customers are unambiguous and clear
l Guides the stipulation of changes in terms and conditions, especially where fee rises. The regulations also applies to the making of statements and receipts.
l Sets up a regime that enables recovering of errors in internet payments.
l Establishes rules to be followed to determine the party that should take the responsibility for unauthorised transactions
Part 3: Capital Budgeting and Project Evaluation
3.1. Capital Budgeting Decision Making (7 marks)
1. Selection of relevant method
The most relevant method out of the five investment criteria of Net Present Value (NPV) is Equivalent annual cost (EAC). EAC is essential in the process of capital budgeting as it allows for comparison of various assets’ cost-effectiveness and helps to decide a better option between leasing and purchasing of outright of an asset (Schoemaker, Verlaan, Vos, & Kok 2016, p.20005). Although EAC involves estimation of discount rate, which can lead to inaccurate forecasts, it is the most suitable for projects with potential to generate same revenue despite their differences in useful lives (Beadnok 2022). Additionally, EAC calculation reveals the future effect of maintenance costs on the asset.
Payback period (PB) tools also do not fit in the project. The simple PB is not suitable because it ignores the time value of money and only concentrates on the payback of initial investment, not future profitability (Al-Ani 2015, p.471). Discounted PB has more advantages over simple PB because it considers present value of future cash inflows to determine the time period when a project’s initial investment will be recovered and focuses on the time value of money (Boardman, Reinhart, & Celec; Al-Ani 2015). Unlike EAC, however, PB techniques are only applicable to projects that have different useful lives and equal initial outlay (Beadnok 2022). Neither of the PB methods can, thus, be used because the two project have different initial outlays.
Profitability Index (PI) focuses on time value of money, considers all the relevant cash flows, and is not impacted by cash outflows (Belyadi, Fathi & Belyadi 2017). However, PI is best for instances where a company must generate cash flow from limited financial resources (Beadnok 2022). The conditions do not apply to the current situation. Lastly, Internal Rate of Return (IRR) derives time value of money and covers all future years (Magni 2010) but is unsuitable for the current case because it applies to situations where the annual return on investment changes from one year to the next.
2. Presentation of Recommended Option
EAC = 
)/i
The maximum benchmark of payback for the the company 3 years
Options A &B
NPV (PV of total cost) = CF0+CF1/(1+r)+CF2/(1+r)2+….CFn/(1+r)n
NPVA=1,420,000+36,000/1.11+36,000/1.112+36,000/1.113+36,000/1.114= -1,420,000+111,688.045= 1,531,688.448
NPVB = 1,530,000+39,000/1.11 +39,000/1.112+ 39,000/1.113+ 39,000/1.114+ 39,000/1.115 = 1,674,114.316
EACA = 1,531,688.448
{[1-(1+0.11)-4]
0.11} = 493,703.55
EACB =1,674,114.316
{[1-(1+0.11)-5] 
0.11} = 539,611.16
Investment with the lowest EAC is chosen. In this case, Option A is selected as its EAC (493,703.55) is lower than that of Option B. In other words, Option A has better cost efficiency as it requires less operation and maintenance cost.
3.2. Risk Analysis and Project Evaluation: NPV Scenario Analysis (8 marks)
A. Based Case
Step 1: Calculating NPV of Based Case
ITEM | AMOUNT |
Initial investment | $1,250,000 |
Project and equipment life | 5 years |
Residual value of equipment | $250,000 |
Working capital required | $160,000 |
Depreciation method | Straight line [(Initial value-residual value)/useful life] |
Depreciation expense | 200,000 |
Unit sales | 3,500,000 |
Unit price | $3.5 |
Variable cost per unit | $1.2 |
Cash fixed cost | $50,000 per year |
Discount rate | 10.5% |
Tax rate | 30% |
Step 2: Calculating NPV of Based Case
| Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
Revenue |
| 12,250,000 | 12,250,000 | 12,250,000 | 12,250,000 | 12,250,000 |
Less: Variable cost |
| 4,200,000 | 4,200,000 | 4,200,000 | 4,200,000 | 4,200,000 |
Less:Depreciation expense |
| 200,000 | 200,000 | 200,000 | 200,000 | 200,000 |
Less: fixed cost |
| 50,000 | 50,000 | 50,000 | 50,000 | 50,000 |
Operating profit |
| 7,800,000 | 7,800,000 | 7,800,000 | 7,800,000 | 7,800,000 |
Less: Tax |
| 2,340,000 | 2,340,000 | 2,340,000 | 2,340,000 | 2,340,000 |
NOPAT |
| 5,460,000 | 5,460,000 | 5,460,000 | 5,460,000 | 5,460,000 |
Plus: Depreciation expense |
| 200,000 | 200,000 | 200,000 | 200,000 | 200,000 |
Less/add increase in CAPEX | -1,250,000 |
|
|
|
| 250,000 |
Less/add increase in working capital | -160,000 |
|
|
|
| 160,000 |
Free cash flow | -1,410,000 | 5,660,000 | 5,660,000 | 5,660,000 | 5,660,000 | 6,070,000 |
PV | -1,410,000 | 5,122,172 | 4,635,450 | 4,194,977 | 3,796,359 | 3,684,489 |
NPV | 20,023,448 |
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B. Worst Case
Step 1: Calculating Worst Case
ITEM | AMOUNT |
Initial investment | $1,250,000 |
Project and equipment life | 5 years |
Residual value of equipment | $250,000 |
Working capital required | $160,000 |
Depreciation method | Straight line [(Initial value-residual value)/useful life] |
Depreciation expense | 200,000 |
Unit sales | 3,150,000 |
Unit price | $3.15 |
Variable cost per unit | $1.32 |
Cash fixed cost | $55,000 per year |
Discount rate | 10.5% |
Tax rate | 30% |
Step 2: Calculating Worst Case
| Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
Revenue |
| 9,922,500 | 9,922,500 | 9,922,500 | 9,922,500 | 9,922,500 |
Less: Variable cost |
| 4,158,000 | 4,158,000 | 4,158,000 | 4,158,000 | 4,158,000 |
Less: Depreciation expense |
| 200,000 | 200,000 | 200,000 | 200,000 | 200,000 |
Less: fixed cost |
| 55,000 | 55,000 | 55,000 | 55,000 | 55,000 |
Operating profit |
| 5,509,500 | 5,509,500 | 5,509,500 | 5,509,500 | 5,509,500 |
Less: Tax |
| 1,652,850 | 1,652,850 | 1,652,850 | 1,652,850 | 1,652,850 |
NOPAT |
| 3,856,650 | 3,856,650 | 3,856,650 | 3,856,650 | 3,856,650 |
Plus: Dereciation expense |
| 200,000 | 200,000 | 200,000 | 200,000 | 200,000 |
Less/add increase in CAPEX | -1,250,000 |
|
|
|
| 250,000 |
Less/add increase in working capital | -160,000 |
|
|
|
| 160,000 |
Free cash flow | -1,410,000 | 4,056,650 | 4,056,650 | 4,056,650 | 4,056,650 | 4,466,650 |
PV | -1,410,000 | 3,671,176 | 3,322,332 | 3,006,635 | 2,720,937 | 2,711,256 |
NPV | 14,022,336 |
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C. Best Case
Step 1: Calculating Best Case
ITEM | AMOUNT |
Initial investment | $1,250,000 |
Project and equipment life | 5 years |
Residual value of equipment | $250,000 |
Working capital required | $160,000 |
Depreciation method | Straight line [(Initial value-residual value)/useful life] |
Depreciation expense | 200,000 |
Unit sales | 3,850,000 |
Unit price | $3.85 |
Variable cost per unit | $1.08 |
Cash fixed cost | $45,000 per year |
Discount rate | 10.5% |
Tax rate | 30% |
Step 1: Calculating Best Case
| Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
Revenue |
| 14,822,500 | 14,822,500 | 14,822,500 | 14,822,500 | 14,822,500 |
Less: Variable cost |
| 4,158,000 | 4,158,000 | 4,158,000 | 4,158,000 | 4,158,000 |
Less: Depreciation expense |
| 200,000 | 200,000 | 200,000 | 200,000 | 200,000 |
Less: fixed cost |
| 45,000 | 45,000 | 45,000 | 45,000 | 45,000 |
Operating profit |
| 10,419,500 | 10,419,500 | 10,419,500 | 10,419,500 | 10,419,500 |
Less: Tax |
| 3,125,850 | 3,125,850 | 3,125,850 | 3,125,850 | 3,125,850 |
NOPAT |
| 7,293,650 | 7,293,650 | 7,293,650 | 7,293,650 | 7,293,650 |
Plus: Depreciation expense |
| 200,000 | 200,000 | 200,000 | 200,000 | 200,000 |
Less/add increase in CAPEX | -1,250,000 |
|
|
|
| 250,000 |
Less/add increase in working capital | -160,000 |
|
|
|
| 160,000 |
Free cash flow | -1,410,000 | 7,493,650 | 7,493,650 | 7,493,650 | 7,493,650 | 7,903,650 |
PV | -1,410,000 | 6,781,584 | 6,137,180 | 5,554,009 | 5,026,252 | 7,152,624 |
NPV | 29,241,649 |
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D. Scenario Analysis
Value Driver | Base Case | Worst Case | Best Case |
Unit sale | 3,500,000 | 3,150,000 | 3,850,000 |
Price sale | $3.50 | $3.15 | $3.85 |
Variable cost/unit | $1.20 | $1.32 | $1.08 |
Fixed cost per year | $50,000 | $55,000 | $45,000 |
Total revenue | $12,250,000 | 9,922,500 | 14,822,500 |
Total variable cost | 4,200,000 | 4,158,000 | 4,158,000 |
Scenario Analysis
Scenario | NOPAT | Free cash flow (Year 1-4) | NPV |
Base Case | 5,460,000 | 5,660,000 | 20,023,448 |
Worst Case | 3,856,650 | 4,056,650 | 14,022,336 |
Best Case | 7,293,650 | 7,493,650 | 29,241,649 |
Explanation:
Worst and best case assessment outcomes show that although the project expectation is that it produces NPV of $20,023,448, its NPV might rise to $29,241,649 or drop to $14,022,336. The investment opportunity is, thus, less risky as both the best and worst cases have positive NPV.
Conclusion
Several essential skills have been shared by our lecturers to us through this unit. The group work helped us to realise the valuable information we have learnt and served as a crucial activity for reflecting on the key concepts. Group members realised the benefits of working as a team and consulting the lecturer on challenging topics.
