INSTITUTE OF TECHNOLOGY CARLOW

2014/15

ASSIGNMENT 2

Programme:

Masters in Business

Module:

Financial Analysis & Investment Appraisal

Prepare a report for the board of directors of Great Flights plc concerning the proposed
expansion plans.

In the report, you should include the following:

1. Calculate the net present value and payback period of the proposed plans. (30
marks)
Net present Value
Net present value is the value of present net cash inflows. The value is a reliable measure
to use in capital budgeting. It is very important for the investment, as it accounts the time
value through cash flows use. While calculating the net present value, the target rate is set
for the analysis of the cash inflows projects (Explained, 2014).
Advantages of the net present value
It is a beneficial measure in accounts for the valuation of the money. It is the most reliable
technique, which do not discount the future cash flows for the pay back periods and the
accounting rate for return.

Disadvantages of the net present value

The estimation of the net present values are based on the future cash flows of the business
projects. Its estimations can be far from the actual and exact results.
Formula of Net present Value
The formula of Net Present Value (NPV) is used to describing the present value of an
investment project by the discounted sum of all cash flows, received through the project
(Formulas, 2014). The formula of net present value is as below;

1 (1 + I)-n
Initial Investment

NPV = R
I

When any investor or the company takes part in any project or investment, then it is the
important stage to knowing the estimation processes for the profits calculations. In the
form, -Co is the sign of initial investment that shows the negative parts of the cash flow of
opposite money directions. If the money is going towards the subtracted from the
discounted sum of cash flows, then the value of net present value will be positive by
showing the impressive and valuable trends of the investment.

Payback period of the plan

The payback period is a simple way to analysing the different ideas of any business plan.
The main objective of the payback period plan is to getting back the invested money,
which was spent on the project before it. The formula of the pay back is (solutions, 2014);
Payback Period =Initial Investment / Cash Inflow per Period
In case of uneven cash flows, the formula will be such as
Payback Period = A +B / C
A stands for the last period of cash flow with negative cumulative
B stands for the absolute vale of the cumulative cash flow, which was ended at the end of
period A
C stands for the total cash flow, during the specific period after time A
Advantages of payback period
It the very simple and easy way to calculate the given data for output. It is a useful
measure to inherent the project in case of any risk. The occurrence of the uncertainty of
the cash flows is unpredictable, but the payback period plans describes the certain
conditions of the cash inflows very earlier. Some companies face the liquidity problems;
in this case, the payback period provides best plans to improve the ranking for the return
of the money.
Disadvantages of payback period
There are a few disadvantages concerned to the playback period. There is no proper
solution for the taking account the time value of the money, which can be a cause of
drastic drawbacks to leading the immoral judgments. To decrease the effects of
drawbacks, the method of discount payback period is adopted to attempt the variations.

There is no credibility account to know the occurrence of the payback period cash
inflows.
Calculations of the net present value and payback period of the proposed plans
Income statements for the year to 30 September

Year of new strategy

Year 2

Year 3

Year
4

Ancillary revenues
Revenue from seat sales
Employee costs
Fuel and oil
Maintenance
Depreciation
Marketing
Route charges
Airport charges
Miscellaneous expenses
Operating profit
Net interest charges
Profit before taxation
Tax
Profit for the year
Discount Rate = 30.625

Discount Rate = 30.625

Initial invest amount = 9
Number of years = 3

35
m
380
(52)
(54)
345
(15)
(48)
(25)
(28)
(45)
(18)
95
(20)
75
(25)
50

42
m
457
(67)
(68)
415
(22)
(51)
(23)
(35)
(59)
(13)
119
(14)
105
(31)
74

52
574
m
(81)
(95)
(25)
522
(52)
(20)
(48)
(79)
(30)
144
(18)
126
30
96

Year

Cash flow

Present value

40

38.28

76

44.54

96

43.07

Present net value of the proposed project = 116.89

Calculation for Payback period of the plans

Initial investment amount = 9

Number of years = 3
Year

Cash flow

40

76

96

Payback period = 0.127 years

Average annual cash flow = 70.667

2. Using the population data and the Netta Group estimates re-calculate the net
present value and payback period using an alternative approach to predicting the
incremental cash flows to act as a check on the reliability of the
calculations provided in your answer to (i) above;(16 marks)
Recalculating net present value and payback period of the population data and the Netta
Group estimates
Approaches to predicting the incremental cash flows
Incremental cash flow is a term, which is used in operating the calculation process of any
firm or organisation. The positive results of the increment cash flow results in the increase
in the companys financial revenues for accepting the new projects. Different components
of the incremental cash flows describe the true identifications of any project; such as, cash
flows from the receiving of any project, terminal costs, initial outlays, and the timing scale
of any project. Based on the incremental cash flows predictions, the financial companies
expand or reduce their financial activities to find great revenues (Yoder, 2006). There are
some approaches to predicting the incremental cash flows;
1. Sunk costs
To analyse the project at the initial stages, sunk cost analysis is necessary for the best
predictions. The analysis of the sunk costs describes that these costs will not influence the
future cash flows of the projects during the budgeting making decision.
2. Opportunity costs
Opportunity costs do not go forward with the cash outflows, which will not be earned
easily by using maximum output for the project. For the predictions of the incremental
cash flows approaches, the opportunity costs work as externalities by benefiting the
project very easily.
3. Externalities

While considering the incremental cash flows of any new project, many new effects
happen during the companys operations for possible considerations. These possible
considerations are called externalities.
Predicting the incremental cash flows formula
Incremental Cash Flows = Cash Inflows Cash Outflows Taxes
Taxes = (Inflows Outflows Depreciation Expense) Tax Rate
Incremental Cash flows = Cash Inflows Cash Outflows (Inflows Outflows
Depreciation) Tax Rate
4. Cannibalizations
It is the type of externality, which describes the state of the projects for the sales by taking
away the present product.

Recalculating net present value of the population data and the Netta Group estimates
Year of new

Year 5 Year 6 Year 7 Year Year 9 Year 10 Year 11 Year

Eastern Europe
strategy

12

population
165.3
(millions)
Discount Rate = 30.625

164.5

163.1
162.2

Initial invest amount = 9

Number of years = 8

161.8

160.5

158.4

158.1

Year

Annual cash flow in

Present value

165.3

126.55

164.5

96.41

163.1

73.18

162.2

55.71

161.8

42.54

160.5

32.31

158.4

24.41

158.1

18.65

Net present value = 460.76

Recalculating the payback period of the population data and the Netta Group estimates
Year of new strategy Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11
Eastern Europe

Year
12

population
Initial
investment amount = 9
(millions)
Number of years =

165.3

164.5

163.1

162.2

161.8

Year

Annual cash flow in

165.3

164.5

163.1

162.2

161.8

160.5

158.4

160.5

158.4

158.1

158.1

Payback period = 0.056

Average annual cash flow = 161.7374
Checking reliability of the answers
3. Calculate the sensitivity of the net present value calculations in (I) and (I) above
to the possible options relating to the weighted average cost of capital. (12 marks)
Weighted average cost of capital
The companies and organisations have numerous sources to run the business activities.
These business or financial activities are known as the common stock, preferred stocks,
retained earnings and the debts. Weighted average cost of capital is a type of average cost,
which is gotten after the tax collections of all resources. The calculation method of the
weighted average cost of capital is achieved by the multiplying costs of each source of the
finance related by the weights and the products summing (Explained, 2014).
WACC is mostly used in discounting cash flows for the calculations of net present value
and for the other investment projects analysis. The term WACC describes the
organisations average risks. For the adjustments of the risks, the WACC provides
reasonable solutions to decrease the rate of risks.
Formula of Weighted average cost of capital (WACC)
If a company has two specific sources for financial activities, which are debt and equity,
then WACC will be such as;
WACC = weight of equity x cost of equity + weight of debt x cost of debt
The calculation of cost of equity are based on different models of calculations, such as
divided growth model and the capital asset price model.

The calculation of cost of debt is based on the yielding maturity for the relevant
instruments. If there are no yielding maturity for calculations, then cost of debt is
calculated based on current yielding instruments.
For the detailed analysis of any business plan, the formula will be such as
WACC = E / V * Re + D / V * Rd * (1 Tc)

Where:

Re = cost of equity

Rd = cost of debt

E = market value of the firms equity

D = market value of the firms debt

V=E+D

E / V = percentage of financing that is equity

D/ V = percentage of financing that is debt

Tc = corporate tax rate

Calculation of the Weighted average cost of capital

Cost of equity = 60%

Total Equity () = 1178
Cost of debt = 6%
Total of debt = 385
Corporate tax rate = 20%
WACC= 46.40 %

4. State what additional information would be required before a final decision is made as to
whether the plans should go ahead (12 marks)
Net present value of the business plan is positive, which is a good indicator. The given business
plan needs suggestions and decisions to take further steps. To run a business efficiently, the
management of the business should adopt new stratiegies to expand the business.
For the successful measure of a business plan, the role of net present value is very strong. The
positive numerical calculations help for the profitable revenues in the future. For the long term
projects, the plan should go ahead. It will give effective revenues for the owners and employees
of the business.
5. Separately comment on the results of your calculations in (i-iii) above. (12 marks)
The results of the (1-3) portions are very efficient. No negative signs for the business have seen
based on the calculated results. Positive net value is a good sign for the revenues. Average
annual cash flow is also high. Net present value is also a good indication for the best outcomes.
Debt ratio is high. For this concern, the business management should take effective steps to
decrease the debs and increase the revenues. The business plan is also worked weakly in a few
year, so the activities should run efficiently.

Bibliography
Explained, A. (2014). Net Present Value (NPV). Retrieved from http://accountingexplained.com/
Formulas. (2014). http://www.financeformulas.net/. Retrieved from
http://www.financeformulas.net/
solutions, b. (2014). Payback Period Analysis. Retrieved from http://www.wbsonline.com/
Yoder, T. R. (2006). THE INCREMENTAL CASH FLOW PREDICTIVE ABILITY OF
ACCRUAL MODELS.