To: Bill Jones, Stryker Corporation’s CFO
From: XYZ, Senior Accountant at Stryker
Date: 21-April, 2018
Subject: PCB Project
I am hereby presenting the things for the PCB projects, where we can conclude the possibility of proposal XXX. For this proposal I strictly believe that we should proceed with it because of following facts:
- We can use the available resource of 30,000 sq. feet of Land owned by Stryker and construction of building will not cost more than the variable elements like engineering and architectural costs.
- Positive Cash flow can be realized after Year 3.
- IRR is higher than Hurdle Rate, which makes impact that proposal won’t led the stakeholders money down.
- Payback period could be re-instated in 4.57 years.
Further, if we assume to use the Perpetuity calculation for terminal value, we should understand that the perpetuity calculation has a similar character of a bond that never matures and these can be used in detecting the price preferred stock, which pays a dividend that is a specified percentage of its par value. So, in the given case, we can calculate the value of terminal value by using the same formula; as,
P = D1/ (r-g)
Where, D1 = Final Year’s cash flow
r = hurdle rate/ required rate
g = 0
After calculating the same in the excel sheet, the new Terminal Value = $31,242,993.
With this, we have been able to identify the new NPV = 13,404,897 and IRR = 40.54%
- As the NPV, in the case of perpetuity is higher by 1,518,562 we should opt for perpetuity method in order to calculate the terminal value.
- The Building has life of 30 years, which is supposed to be used for various other purposes, even if the proposal fails in during the years. But in case the proposal is viable in all respect then the cost of building will be utilized for manufacture of PCB for next 30 years, which means that the purchase from manufacturers which is supposed to be increased by 22% each year, will be saved and the cash flow tends to be positive each year at the rate of 31%.
- Capital equipment will be durable for 7 next year and the IT equipment will be durable for 3 years. Though, these Cash outflow will be recurring but as we are supposed to get the positive cash flow since from Year 3 itself we can be able to incur these expenses in future as well. The total cost of IT Equipment is 336,000, which is supposed to be incurred after 3 years is not a big deal as from that year itself we will be generating Positive Cash flow of $2,166,909, which present value tends to $1,424,778. So it is very much acceptable from that point of view.
- As we have the terminal Value of 31,242,993 at the end of year 2009 by means of perpetuity method of calculation, it is very much useful that the Terminal value which is the sum of all cash flows from an investment or project is beyond a forecast period based on a specified rate of return, is higher.
- As already discussed the pay back period is 4.57 years which means that the though the project is of 7 years or more, the working capital will be re-back within 4.57 years of time. The Proposal that leads to get the money in quick 60% of time is always viable with a projection that the company will continue to the operation in next many years.
- The company has been supposed to be possible that the NPV may not be recovered due to many variable constraints like the Tax rates, manufacturing costs. But as even in such situation the NPV will be recovered as the NPV is 24% of the total cost of the company incur for manufacturing. It means, even if such variable constraints increase by 24% (which is not possible, at such high rate), the company will be financially viable to opt for this proposal.
- The discounting rate may be increased to certain rates, but even if the increased to double figures upto 30% around, the cash flow will be $3,513,562.
Accumulating all the possible situation which could may lead the NPV to failure has been supposed to be an extra-ordinary situations but in such situations too the NPV of the company has a potential to recover a financially viable option than other. If we consider this option, we already know that the quality and delivery option for the company will get settle down and the market share will increase. Once the control over the production is in the hand of the company we can plan for increment of the production plan and the profit ratio will increase accordingly.
# The Tables has been shown below for the purpose of the working NPV and Payback period.
|By Using Formula|
|D1 = Final Year’s cash flow|
|r = hurdle rate/ Required rate|
|g = 0|
|D1 = 4686448.81|
|New Terminal Value||31,242,993|
|Subtotal of Cash Flows||-177920||-749931.68||-301384.3594||2166909.625||3027638.681||3586148.768||4686448.81|
|Terminal value (at book value)||31,242,993|
|Discount factor 15%||$ 1.0000||$ 0.8696||$ 0.7561||$ 0.6575||$ 0.5718||$ 0.4972||$ 0.4323|
|Present value of cash flows||(177,920)||(652,115)||(227,890)||1,424,778||1,731,062||1,782,950||2,026,081|
|Present value of terminal value||13,507,208|
|Sum of PV of cash flows and terminal value||19,414,155|
|Less initial investments:|
|IT & Other Equipment||(336,000)|
|Net Present Value||$13,404,897|
|% NPV||$ 24.39|