Essay: Financial Data Analysis For RJR Nabisco Acquisition.

For your analysis, Year 0 is 1988 and year 1 is 1989. Financial data are as follows:  

• The purchase in 1988 requires an initial capital investment of $24 billion and $150 million of working capital.
• Additional capital expenditures are required each year:
  • $1.7 billion in 1989
  • $1.4 billion in 1990
  • $1.3 billion in 1991
  • $930 million in 1992
  • $735 million in each subsequent year up to and including the year 2000.
• Additional working capital allocations are required each year:
  • $158 million in 1989
  • $165 million in 1990
  • $170 million in 1991
  • $200 million in 1992
  • In each subsequent year up to and including the year 2000, working capital increases at a rate of 4 percent p.a. That is, in 1993 the working capital allocation is $200 x 1.04 = $208 million and so on.   
• The company has two main divisions, food and tobacco. For the food division, 1989 sales are expected to be:
  • Nabisco cookies and crackers, $5 billion
  • Canned vegetables, $500 million
  • Canned fruit, $300 million
  • Ready-to-eat and hot cereals, $750 million
  • Planter’s peanuts, $800 million
  • Lifesavers, $400 million
  • Chocolate bars, $300 million
  • Bubble gum, $200 million
  • Margarine, $200 million
  • Fresh fruit, $700 million
  • Mexican food products, $150 million
  • Special BBQ sauce, $100 million
  • Milkbone dog biscuits, $200 million
  • Miscellaneous foods, $1.6 billion
• For the tobacco division, sales in 1989 are expected to be $7.56 billion.
• For each year after 1989, food sales, in every category, are expected to grow at an industry average of 6 percent p.a. whilst tobacco sales are expected to grow at 7 percent p.a.
• In 1989, the cost of goods sold in the food division is expected to be $8.73 billion p.a. This amount is expected to increase at a rate of 4.50 percent p.a. That is, as sales grow year by year there are improvements in cost margins.
• In 1989, the cost of goods sold in the tobacco division is expected to be $5.1 billion. This amount is expected to increase at a rate of 5 percent p.a. As for the food division, there are improvements in cost margins as sales increase.
• The depreciation charge that is appropriate for the acquired company is $810 million in each and every year.
• The corporate taxation rate is 32 percent.  
• The cost of capital for the company is 15.10 percent.
• The life over which the acquisition is to be evaluated is 20 years. Year 0 is 1988, year 1 is 1989, year 20 is 2008.
• Your firm has spent $10 million researching this potential take-over target and determining all of the cash flows listed above.
• All of the working capital is returned in the final year of the project.
• If you have a negative EBIT in any given year, the taxation for that year is zero.

Compute the NPV and IRR for the project in order to determine whether the acquisition of RJR Nabisco will generate value for your fund’s investors.

The following are the various calculations:

Conclusion: 

From the above stated analysis, it can be stated that the project must not be accepted since the net present value from the project is negative. This merely means that the outflow from the project would be more than the inflow and hence, the project must not be accepted. Also, the internal rate of return derived from the project is negative, hence, the project must not be accepted.

The net present value helps in comparing the amounts that have been invested in the project with the present values of all of the future cash receipts from the investment.

The following are its advantages and disadvantages:

• It is a direct measure of the investment made by the stockholders
• But with the IRR method, it shows the return that the stockholders receives on their investment.
• The size of the project is not capable of being measured
• But with the method of IRR, the sometimes gives the conflicting answers when the same is compared with the net present value method (Small business chron, 2017).

This is the rate of the return that is used for the purposes of measuring the profitability of all of the potential investments. This is the rate of discount that makes the net present value of all of the cash flows from one particular project to equal to 0. This means that the calculations could be relied on using the same formula as the concept of net present value does (E finance management, 2017).

The following are the advantages and disadvantages of the same:

• It uses the time value of money theory
• All of the cash flows are important

The following are the disadvantages of the same:

• It is difficult to be understood
• It undertakes some of the unrealistic assumptions (SV tuition, 2017).

References:

Bornholt, G. (2017). Advantages and Disadvantages of Internal Rate of Return (IRR). [online] eFinanceManagement. Available at: https://efinancemanagement.com/investment-decisions/advantages-and-disadvantages-of-internal-rate-of-return-irr [Accessed 5 May 2017].

Kumar, V. (2017). Advantages and Disadvantages of Internal Rate of Return. [online] Svtuition.org. Available at: https://www.svtuition.org/2010/05/advantages-and-disadvantages-of.html [Accessed 5 May 2017].

Smallbusiness.chron.com. (2017). Advantages & Disadvantages of Net Present Value in Project Selection. [online] Available at: https://smallbusiness.chron.com/advantages-disadvantages-net-present-value-project-selection-54753.html [Accessed 5 May 2017].