Week 4 Final Project

WEEK 1

The company I choose is 1-800-Flowers.com. This falls in either the industry of Other Personal Services or Other Online Retailers. From what I found, this company is not very profitable. The profit margin has ranged between 3% and 10% over the past four years. This shows that the company has high operating expenses. The trend that I found whit this company is that it remains fairly unchanged over the four years except for a spike in 2012. 2012 is the year that the profit margin jumped to 10%. The only industry averages that I could find for the financial ratios were from 2012. The industry average for the return on assets was 44.16%, which is substantially higher than the 7% that I came up with for this company. This company needs to figure out a way to turn over more sales at a lower cost of goods sold in order to raise its profit margin and asset turnover. They need to bring their expenses down also in order to increase their net income.

Week 2

Interpretations

Question (A)

It is vital to note that the three most significant components of present value are time, expected rate of return, and the size of the future cash flow. To account for inflation in the calculation, investors should use the real interest rate (nominal interest rate - inflation rate). If given enough time, small changes in these components can have significant effects.

Question (B)

The formula: IRR = (FV / PV) ^ (1 / N) - 1 only applies to a single investment (no additional investments or withdrawals).  IRR can be thought of as an interest rate that, if applied to each transaction during the time it's invested, produces the final figure. 

Question (C)

To determine the value of a common stock using the dividend growth model, you first determine the future dividend by multiplying the current dividend by the decimal equivalent of the growth percentage (dividend x (1 + growth rate)). Lastly, the future dividend is divided by the difference between the decimal equivalent of expected rate of return and the decimal equivalent of the growth percentage (future dividend ÷ (expected rate of return - growth rate)).

Question (D)

A bond that pays 1 coupon(s) of 5.00% per year, that has a market value of $987.00, and that matures in 16 years will have a yield to maturity of 5.12%. This means that bond investors don't just buy only newly issued bonds (on the primary market) but can also buy previously issued bonds from other investors (on the secondary market). Depending on whether a bond on the secondary market is bought at a discount or premium, the actual rate of return can be greater or lower than the quoted annual coupon rate. This is why bond investors need to look at YTM, which measures the bond's yield from the day the investor buys it to the day it expires, when the principal is paid to the bondholder.

It means if you buy this bond today, you will earn 6.51% per year if the bond is called on the call date. It’s important to note that if the bond you’re analyzing is not callable. The YTM and YTC when calculated using semi-annually, they change because the time taken to give the yields has been changed.

Week 3

What is the total investment in the new machine at time = 0 (T = 0)?

Total investment in new machine was USD 312,000 i.e. purchase price plus installation cost.

(Shwizer CFA Level 2 Book 2, Capital Budgeting, n,d)

What are the net cash flows in each of the 5 years of operation?

Year	1	2	3	4	5
Cost saving	105500	105500	105500	105500	105500
After tax saving	68575	68575	68575	68575	68575
Depreciation	62,400	99,840	59,904	35,942	35,942
Tax saving due to depreciation	21840	34944	20966.4	12579.84	12579.8
After-tax operating cash flows	90415	103519	89541.4	81154.84	81154.8

(Shwizer CFA Level 2 Book 2, Capital Budgeting, n,d)

What are the terminal cash flows from the sale of the asset at the end of 5 years?

TNOCF = SalT + NWCinv - T (SalT - BT)

Year	5
Salvage value	25,000.00
WCI	11,000.00
Book value	17,971.20
Tax on profit on sale of asset	2,460.08
Terminal cash flows	33,539.92

(Shwizer CFA Level 2 Book 2, Capital Budgeting, n,d)

What is the NPV of the investment? What is the IRR of the investment? What is the payback period for the investment?

Year	Cash flow
0	(323,000.00)
1	$90,415.00
2	103519
3	89541.4
4	81154.84
5	114694.76
NPV	18,509.65
IRR	15%
Payback period	3 Y 6 months

What is the profitability index for the investment?

PI index = PV of future cash flows / Initail investment

Initial investment	323,000.00
Present value of future cash flows	341,509.65
PI	1.06

(Investopedia, PI, n.d)

According to the decision rules for the NPV and those for the IRR, is the project acceptable?

Under the NPV rule a project is accepted if it has s positive NPV whereas under the IRR rules a project is acceptable if it has an IRR greater than the hurdle rate. The results of the project indicate that it has a positive NPV and the IRR of 15% is greater than the hurdle rate of 11.99% hence the project is acceptable.

Is there a conflict between the two decision methods? If so, what would you use to make a recommendation?

No conflict was observed in the results of the IRR and NPV decision method. If however a conflict arises the recommendation would then be based on NPV results as it directly impacts the shareholder wealth as it indicated the value a project will add to the company. (Investopedia, Advantages and disadvantages of NPV and IRR, n.d)

What are the pros and cons of the NPV and the IRR? Explain your answers.

NPV has a number of distinct advantages. Firstly it provides users with a straight forward decision rule i.e. if a project has positive NPV it should be accepted. Secondly the NPV method directly measures the amount of value a particular project would add to the business. IRR on the other hand has the advantage that it allows the decision maker to determine the amount of return generated on the original money invested.

Both of the decision methods however have some flaws. Firstly, NPV method fails to incorporate in the decision making the size of the project i.e. it does not consider the level of value being generated in contrast to the money being invested all it looks for is weather the overall value is positive. IRR on the other hand has been observed to generate results that are conflicting to those generated by the NPB method especially for mutually exclusive projects. Further IRR may also be negative for some projects making decision making complicated. (Investopedia, Advantages and disadvantages of NPV and IRR, n.d)