Weighted Average Cost of Capital (WACC)


            (See requirement 1)


 


Analysis and Recommendations on Each Project


            Using the net present value (NPV) method, the following implications are obtained.  It should be noted that all the projects (e.g. from project 1 to 5) have positive NPVs which mean that they are all worthwhile investments.  In the contrary, our concern is to assess their associated business risk or perhaps the “preferential” timing of cash flows.  Project 1 provides an NPV of 31,470 (see requirement 2) but there is risk in not having a sure market as cash flow will rely on membership fees and time spent on the site.  In addition, the continuous service of the system is also at risk of interruption if troubleshooting is going-on because only one server, which is the minimum resource required in the project, is in function.  If inconvenience happens, the market would pull-out membership and support.  The initial outlay of ,000 may not be fully recovered knowing that the bulk of cash flows are at the terminal year of the project.


 


            Project 2 has almost the same NPV as project 1 at 30,092 (see requirement 2).  Their risk difference and timing of cash flows, however, makes project 2 more lucrative.  First, the project intends to cater to already developed market and said to easily reach market maximum.  Such scenario only makes the project continuously profitable, might be increasing and less risky.  This statement is concretized as project 2 can recoup the initial outlay as early as the second year netting by 11,000.  This timing of cash, considering the matured market targeted by project 2, will positively pressured year-on-year until the product reach its declining phase.  The bottleneck of project 2 is also the same as project 1 in which significant risk lies on having single server which is the minimum resource requirement for such projects.


 


            Therefore, it is recommended that project 1 should undergo market research to assure the presence and subsistence of the market.  Further research is also helpful for project 2 to determine the extended cash flow period for the project and determine when will be the market decline.  For both projects, it is a must that when they are planned to be implemented, at least two servers or more are running.  This is a business strategy and will make their product more competitive due to faster, reliable and efficient access that can be experienced by the customers.  In the contrary, installing a new system especially for project 1 would create a need to hire additional employees and construct offices.  There is a substantial psychic risk (e.g. losing jobs) at stake and this should be noted when evaluating the two projects.   


 


            For project 3 and 4, there is minimal risk involved as the future suggests continuous generation of income from the DVD market.  Further, both projects incurred NPVs of 331,600 (for project 3) and 383,500 (for project 4) (see requirement 2).  If any, the timing of cash flows could be pondered in terms of investment deferral or shift to a more lucrative investment (e.g. engaging in project 5).  As observed, both projects necessitate huge capital outlay amounting to 500,000 which the firm may find “too much” or “too risky”.  As a result, since there is an old burner as well as the fact that each project would result to mass production of DVDs, the more efficient burner in project 3 should be prioritized over the less efficient and less cash flow producer (outlay is covered only after year 5) project 4 burner.  In the end of year 3, the second burner would then be bought only after the outlay for project 3 is obtained and with a net of 49,900.  The recouped outlay of project 3 will finance project 4 at 500,000.


 


            Project 5 (the version of marketing department) tops the NPV of the five projects at 1,545,951.96 with average cash flow timing of five years (see requirement 2).  It makes NPVs of project 1 and 2 relatively insignificant despite the two projects being ahead two years in terms of time value of money while it is 4.66 times bigger than project 3 and 4-times bigger than the 10-year cash flow period of project 4.  Clearly, it adheres to lucrative size, timing and risk of investments.  However, to be able continue the compliments of project 5, the management should double-check the reliability of the initial market research in terms of costing, sales projection and depreciation.  Marketing people are undoubtedly good in sales talk and are naturally optimistic in which their conclusion can be polished by prudent financial managers and visionary leadership.  


 


 


            This is what exactly reflected in the succeeding computation (see requirement 2) when projected unit sales is reduced by 20% as well as increase in variable costs of 20%.  As a result, NPV is reduced by 1,133,817.29 from the marketing version to 412,134.67 of the management version.  With this, project 5 is comparable to project 3 with the latter being the safer investments because of continuous generation of income in the DVD market.  The recommendation would be to study further project 5 and perhaps do a business plan before its approval.  As observed, the project requires almost 2M in initial investments which can sufficiently finance (not to mention substantial savings) project 1 to 4.  However, if the firm persists and they are more inclined in developing their learning curve, organizational cohesion and mindset should be allotted in the exporting project while exchange currency fluctuations and risks should be hedge by investing in securities markets.                   


             


Analysis and Recommendations on Working Capital Management


            As shown in requirement 3, Eager has an elapse time of 297 days (its operating cycle) in 2005 between the time raw materials are delivered and when payment for the finished product manufactured from those materials is received from customers.  However, Eager cannot operate its day-to-day activities within this 297 days cycle without the 77 days spontaneous financing received from its suppliers.  The net financing requirement of 221 days is the period that is used to compute the required funds that should be available to bridge the financing gap otherwise Eager cannot continue to operate.  Requirement 3 shows that the firm should have access to short-term financing of approximately 45M and essentially having to finance 221 days worth of sales valued at their cost price. 


 


            In 2006, Eager has prolonged its financing gap to 270 days perhaps by having attractive contracts with longer payment dates (56 days, in terms of credits) and also with shorter ones (in terms of debts).  However, it increased the required short-term financing at 53M.  This situation is the usual tenet of financial management which is the trade-off of returns to risks.  As financial risks decrease due to longer credit days, returns decrease due to longer operating cycle (at 327 days), longer debtor days (at 100 days) and slower inventory turnover (at 226) which affect availability of stocks and payment of debtors which reduce working capital.  It is therefore apparent that for the succeeding years it is important to effectively market the product (for faster inventory turnover), efficiently produce the product (for faster semi-finished inventory turnover) and creation of harmonious relationship with both debtors and creditors (to obtain reconciliation settlements in times of working capital bottleneck).


 


Recommendations for Appropriate Short-term Financing


            Since Eager has high beta, it is ideal to use equity financing.  Investors require a rate of return higher than the market average and a beta of 1.5 is simply an indication that Eager shares provide returns 50% higher on every dollar return in the market average.  Complementarily, debt refinancing can be obtained easily as the company has historically no loan renewal problems but the firms should be able to settle a fixed-interest rate.  Refinancing is common in mortgages and the competition result in offering fixed-interest rates in which Eager can exploit when it has ongoing obligation over a fixed asset.  This will lessen interest payments and increase working capital momentarily. 


 


Overall Strengths and Weaknesses


            The decline in 2006 EBIT indicates that the company is having difficulty in selling its products as well as the major costs associated in producing and distributing them.  Investments should be made in product development and product diversification rather than marketing.  Borrowing costs is increasing which could mean that the firm is not shielded with interest rate fluctuations and transaction costs.  Equity financing should be focused.  Since ordinary share capital is not increased for two consecutive years, the firm can issue additional shares to mitigate rising borrowing costs.  A fall in income tax is a supportive account in equity financing but the firm should study because this would be the effect of tax-deductible debt which is mitigated herein.  Retained profits on the other hand support product diversification and development.  Using Du Pont analysis and strategy, product development is rationalized.  Du Pont intends to focus on science-based innovation wherein returns are expected to kick-off in 2010.  With this mindset, Eager can use its substantial assets and retained earnings to finance product development without the worry of timing of money even it takes five years at most.  Commercialization of the developed/ diversified product is also easy because the company do business virtually. 


Bibliography


Appendix


(See attached spreadsheet)                          


 


 


                  


          


 


             


           



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