Analysis Of P-Rec And T-Rec Projects

Using Excel Spreadsheet, prepare a full analysis for the CFO of ALLCURE Inc. to assist in evaluating whether either project should be started or not. Your analysis should include the following

• Table of cash flows (show all digits, do not convert amounts to $ in million or thousand).
• Use of ‘excel formulae’ where appropriate (refer eLearning video of Week-6)

• A written report outlining your recommendation as to whether ALLCURE Company should proceed with either project. Justify your recommendations using quantitative and qualitative issues and your analysis of probable risks and benefits relating to the project. Comparison statement is to be presented in a separate section in the report. 

Allcure Inc is currently engaged in researching and developing the next generation diabetes drug that is started in the year 2017. Though the company has already, the firm is in the view that the target result will take additional 6-8 years to get the target result. However, the company is now planning to release revolutionary pre-version of the drug named as P-Rec that is feared to cause health hazard for long term in case of some patients. The report will analyse the P-Rec project in detail as per the demand of the company’s CFO (DeFusco et al. 2015). In analysis part the cost involved with the project and expected earnings from the same will be analysed. Further, the project will be compared with another project T-Rec that is comparative less hazardous than P-Rec but at the same time less effective than P-Rec.

Quantitative 

Considering the given information various methods has been used for analysing the P-Rec project as follows –

• NPV – NPV or net present value is the likely cash flow of any project over the useful life of the same reduced by the initial cash outflow spent for acquiring the project. It is a crucial approach to analyse the decision associated with the investment as it provides the clear to the company management whether the project will add value or wear away the cash of the company. Generally, if the NPV of the project is positive it is accepted as it indicates value addition to the company (Fleten et al. 2016). On the contrary, the project is rejected if the NPV is negative. It can further be used for future capital projects or acquisition of new project. Looking into the computation it can be identified that after considering all the expenses associated with P-Rec project and revenues expected from the same and using 18% as required rate the NPV of the project is $ 9,29,918.36. It is representing that as the NPV is positive the project will add value to the company and will increase shareholder’s value (Shu, Zeithammer and Payne 2016).
• IRR – internal rate of return or IRR represents the rate of interest at which NPV of all the cash flows including positive as well as negative cash flows from the project is equal to nil. It is used for analysing the acceptability of the project and ranking the project where 2 or more mutually exclusive projects are involved. Generally, if the IRR of the project is more than the required rate of return of the company the project is accepted (Santandrea et al. 2017). On the contrary, if the IRR of the project is less than the required rate of return of the company the project is rejected. Looking into the computation it can be identified that after considering all the expenses associated with P-Rec project and revenues expected from the same the IRR of the project is 27%. It is representing that as the IRR is more than the required rate of return that is 18% the project will add value to the company and will increase shareholder’s value (Dhavale and Sarkis 2018).
• Discounted payback period – it is used for computing the time required by the project for break even and recovering the amount of initial cash outflow required for acquiring the project. For computing discounted payback period discounted cash flow of the project is considering. Here, the required rate is used as the discounting rate for computing the future cash flows. Generally, if the company does not have any specific requirement for the payback period, the project is accepted if the same is less than the useful life of the project (Qiu, Wang and Wang 2015). Looking into the computation it can be identified that after considering all the expenses associated with P-Rec project and revenues expected from the same and using 18% as required rate the discounted payback period of the project is 5.61 years. It is representing that the initial amount spent for acquiring the project will be recovered in 5.61 years that is less than its useful life that is 8 years (Götze, Northcott and Schuster 2015).  

Qualitative

From the above methods those are used for analysing the acceptability of the project it can be determined that as per the NPV the project is acceptable as the project’s NPV is positive that indicates that the project will add value to the company and will increase shareholder’s value. IRR of the project is representing that the project will be accepted as the same is 27% that is more than the firm’s required rate of return used for the project that is 18%. However, though the discounted payback period of the project is 5.61 years that is less than its useful life that is 8 years, as the required discounted payback period for the project is 5 years the project shall not be accepted.    

Based on the above analysis and interpretation it is recommended that if only the discounted payback period is considered the project shall not be accepted. The decision is justified through the fact and findings that though the NPV approach and IRR approach is fulfilling the acceptability criteria of the project, as the discounted payback period exceeds the required discounted payback period of the project the project shall not be accepted.

Taken into consideration the expected consequence of launching the pre-version of P-Rec, the managers of the company recognised the T-Rec project that will have same initial investment as P-Rec but different cash inflows. Looking into the computation it can be identified that after considering all the expenses associated with T-Rec project and revenues expected from the same and using 18% as required rate the negative NPV of the project is $ 162,550.09 (Gaudard 2015). It is representing that as the NPV is negative the project will destroy the value of the company and will reduce shareholder’s value. Considering the IRR it is found that IRR of the project is 16% that is lower than the required rate of 18%. Further, it is found that as the NPV of the project is in negative the initial outlay is not recovered during the lifetime of the project. Hence, from every aspect it is found out that the project is not profitable and shall not be taken up (Damodaran 2016).

Analysis of P-Rec Project

However, as the WACC of the project varies from 18% to 24%, the CF also asked to analyse both the projects using 24% as required rate. Using 24% as the required rate and keeping other things constant, it is found that for P-Rec project NPV will reduce from $ 9,29,918 to $ 2,44,167, IRR of the project will not change and discounted payback period for the project will increase from 6.61 years to 7.06 years. Hence, at 24% required rate the P-Rec project is still profitable (Gaudard 2015). However, if the company specifies the discounted payback period shall not exceed 5 years to make the project acceptable, it shall not be taken up otherwise the project can be taken up based on the NPV and IRR. On the other hand, if 24% required rate is applied for T-Rec project it can be identified that the NPV will reduce from - $ 162,550.09 to - $ 552,739, IRR of the project will not change and will remain at 16% and discounted payback period for the project will be more than 8 years as the initial outlay will not be recovered during the lifetime of the project (Damodaran 2016). Hence, from every aspect it is found out that applying 24% required rate instead of 18% will make the project more un-profitable and shall not be taken up.

Cross over rate is the rate for cost of capital at which net present value of both the projects are equal. It is that point where NPV of one project intersects the NPV of another project. It is considered as useful approach as it indicates at which rate both mutually exclusive projects are evenly good. If the capital cost of the company exceeds the crossover rate relative attractiveness of both the projects changes (Chandra 2017). Through the computation in excel it is found out that the crossover rate for both the project is 115% which is quite high.

Conclusion

From the above discussion it can be concluded that P-Rec project is profitable at both the discount rates that is at 18% as well as 24%. Further, the IRR is 27% that is more than both the required rate. However, if the discounted payback period shall not exceed 5 years to accept the project, P-Rec shall not be accepted as the discounted payback period is more than 5 years for both the required rates. On the other hand, T-Rec project is not able to fulfil any of the acceptability criteria for both 18% as well as 24% required rate and hence, shall not be accepted in any case. 

References

Chandra, P., 2017. Investment analysis and portfolio management. McGraw-Hill Education.

Damodaran, A., 2016. Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.

DeFusco, R.A., McLeavey, D.W., Pinto, J.E., Anson, M.J. and Runkle, D.E., 2015. Quantitative investment analysis. John Wiley & Sons.

Dhavale, D. G., and Sarkis, J., 2018. Stochastic internal rate of return on investments in sustainable assets generating carbon credits. Computers & Operations Research, 89, 324-336.

Fleten, S. E., Linnerud, K., Molnár, P., and Nygaard, M. T., 2016. Green electricity investment timing in practice: Real options or net present value?. Energy, 116, 498-506.

Gaudard, L., 2015. Pumped-storage project: A short to long term investment analysis including climate change. Renewable and Sustainable Energy Reviews, 49, 91-99.

Götze, U., Northcott, D., and Schuster, P., 2015. Discounted Cash Flow Methods. In Investment Appraisal (pp. 47-83). Springer, Berlin, Heidelberg.

Qiu, Y., Wang, Y. D., and Wang, J., 2015. Implied discount rate and payback threshold of energy efficiency investment in the industrial sector. Applied Economics, 47(21), 2218-2233.

Santandrea, M., Sironi, A., Grassi, L., and Giorgino, M., 2017. Concentration risk and internal rate of return: Evidence from the infrastructure equity market. International Journal of Project Management, 35(3), 241-251.

Shu, S. B., Zeithammer, R., and Payne, J. W., 2016. Consumer preferences for annuity attributes: Beyond net present value. Journal of Marketing Research, 53(2), 240-262