An investor earns returns from a stock in the form of dividend and stock price appreciation. For earning this return, he also has to undertake some amount of risk. Risk is the variability in the price of the stock over a period of time. Higher the risk of the stock, more is the expected return. An investor would undertake a risk return analysis before investing in a stock to see if the stock gives better returns than the market at a lower risk. We have done a risk return analysis for the Flight Centre Travel Group for a period of five years and on the basis of the results, have suggested whether it is a good investment or not.
Capital Budgeting is a process of determining the feasibility of a project comprising of long term investments in terms of profitability. Some of the capital expenditures include purchase of new plant and machinery, introduction of a new product or process etc. there are various techniques in capital budgeting which can be used to analyse the capital investment. Net present value (NPV) is the most important one and a project is accepted only if the NPV is more than 1. A capital budgeting analysis has been done for ABC ltd. where techniques used are NPV analysis, sensitivity analysis and scenario analysis.
The daily returns, monthly returns and yearly returns and yearly standard deviation for the Flight Centre Travel Group are given in the annexure. The analysis has been done for a period of five years from 01-01-2012 to 31-12-2016. Also the systematic risk/market risk using the daily returns of the market has been calculated in the annexure along with the unsystematic risk (Yahoo. Finance, 2017)
On the basis of the above calculations, the beta value for the company’s stocks is 0.92. Beta measures the volatility of the stock with respect to the market and an investor can choose between various stocks depending on the beta and his risk appetite. A beta of 1 means that the movement in the stock price is in tandem with the market and if the market price increases by 10%, the stock price will also increase by 10%. A beta of less than 1 means the stock is more stable and does not move in tandem with the market. This reduces the risk of the stock. Here, Flight Travel Group has a beta of 0.92 which means that if the market price reduces by 10%, the stock price of the company will reduce by only 9.2%, thus implying low risk.
Hence, for investors who prefer a stable and secure investment, this is a good investment. However, investing only in this stock will not maximize the returns. In order to minimize the risks and maximize the returns, it is important to have a diversified portfolio. The market risk measured by beta or systematic risk cannot be fully eliminated but it can be minimized by diversifying the portfolio. Also the unsystematic risk which is the company specific risk is 1.7%. This risk can be eliminated with diversification. In a diversified portfolio stocks of different companies with different beta should be kept. Stocks with beta more than 1 will give high returns when the market is rising and stocks with beta less than 1 will give returns better than the market when the market is falling, thus maintaining a balance. Apart from stocks, an investor can invest in bonds which have very low risk and returns are assured (Damodaran, NA)
Capital Budgeting is a process of analysing an investment expenditure to see if it is profitable to make such capital expenditure or not. There are various techniques to do so like NPV, IRR, payback period etc. The new expansion plant project of ABC Ltd. has been analysed using capital budgeting to see if the company should undertake the investment or not.
The initial investment outlay of the project is:
Building cost |
$24,000 |
Equipment |
$16,000 |
Net working capital |
$12,000 |
Initial investment |
$52,000 |
The operating cash flows over the project’s life are given below:
Year |
0 |
1 |
2 |
3 |
4 |
Annual sales |
|
$80,000 |
$80,000 |
$80,000 |
$80,000 |
Variable manufacturing costs |
|
$48,000 |
$48,000 |
$48,000 |
$48,000 |
Fixed overhead costs |
|
$10,000 |
$10,000 |
$10,000 |
$10,000 |
Depreciation on building |
|
$600 |
$600 |
$600 |
$600 |
Depreciation on equipment |
|
$3,200 |
$3,200 |
$3,200 |
$3,200 |
Total operating income |
|
$18,200 |
$18,200 |
$18,200 |
$18,200 |
Income [email protected]% |
|
$7,280 |
$7,280 |
$7,280 |
$7,280 |
Profit after tax |
|
$10,920 |
$10,920 |
$10,920 |
$10,920 |
Operating cash flows |
|
$14,720 |
$14,720 |
$14,720 |
$14,720 |
The terminal year’s cash flows for the ABC’s expansion project:
Terminal value |
|
After tax salvage value Building |
$17,640 |
After tax salvage value equipment |
$3,680 |
Recovery of working capital |
$12,000 |
Terminal value |
$33,320 |
Working Notes:
Building |
|
Building cost |
$24,000 |
Book value |
$21,600 |
Total depreciation |
$2,400 |
Annual depreciation |
$600 |
Market value |
$15,000 |
Loss on sale |
$6,600 |
Tax on loss |
$2,640 |
After tax salvage value |
$17,640 |
Equipment |
|
Equipment |
$16,000 |
Book value |
$3,200 |
Total depreciation |
$12,800 |
Annual depreciation |
$3,200 |
Market value |
$4,000 |
profit on sale |
$800 |
Tax on loss |
$320 |
After tax salvage value |
$3,680 |
NPV analysis
Year |
0 |
1 |
2 |
3 |
4 |
Operating cash flows |
|
$14,720 |
$14,720 |
$14,720 |
$14,720 |
Initial investment |
-52000 |
|
|
|
|
Terminal value |
|
|
|
|
$33,320 |
Net cash flows |
-52000 |
$14,720 |
$14,720 |
$14,720 |
$48,040 |
Cost of capital @12% |
$1 |
$0.893 |
$0.797 |
$0.712 |
$0.636 |
Present value of cash flows |
-$52,000 |
$13,142.9 |
$11,734.7 |
$10,477.4 |
$30,530.3 |
NPV = $13,885
The project has a positive NPV which makes the project acceptable. A positive NPV means the cash inflows are more than the cash outflow and the project will generate profits for the company. Hence, it is recommended that the company should go ahead with the new plant expansion.
Sensitivity Analysis
It is a technique used to determine the NPV changes with a change in the various assumptions or estimates of the project. This helps the managers in a proper analysis and preparing them for the worst.
The result of sensitivity analysis for the current project by increasing and decreasing the sales, variable costs and cost of capital and their impact on the NPV has been discussed below:
Value Drivers |
Expected NPV |
Revised NPV |
% Change |
Increase in sales by 2% |
$13,885 |
$15,052 |
8.4% |
Increase in sales by 5% |
$13,885 |
$16,801 |
21.0% |
Increase in sales by 10% |
$13,885 |
$19,717 |
42.0% |
Decrease in sales by 2% |
$13,885 |
$12,719 |
-8.4% |
Decrease in sales by 5% |
$13,885 |
$10,969 |
-21.0% |
Decrease in sales by 10% |
$13,885 |
$8,054 |
-42.0% |
Increase in variable costs by 2% |
$13,885 |
$12,136 |
-12.6% |
Increase in variable costs by 5% |
$13,885 |
$9,511 |
-31.5% |
Increase in variable costs by 10% |
$13,885 |
$5,138 |
-63.0% |
Decrease in variable costs by 2% |
$13,885 |
$15,635 |
12.6% |
Decrease in variable costs by 5% |
$13,885 |
$18,259 |
31.5% |
Decrease in variable costs by 10% |
$13,885 |
$22,633 |
63.0% |
Increase in cost of capital by 2% |
$13,885 |
$10,618 |
-23.5% |
Increase in cost of capital by 5% |
$13,885 |
$6,162 |
-55.6% |
Increase in cost of capital by 10% |
$13,885 |
-$253 |
-101.8% |
Decrease in cost of capital by 2% |
$13,885 |
$17,418 |
25.4% |
Decrease in cost of capital by 5% |
$13,885 |
$23,279 |
67.7% |
Decrease in cost of capital by 10% |
$13,885 |
$34,832 |
150.9% |
From the above table we see that cost of capital is the most sensitive factor in this project as with a 10% increase in the cost of capital, the NPV decreases by more than 100%. Also with a decrease in cost of capital by 10%, the NPV increase by 150%, thus making it the most sensitive factor. After cost of capital, it the variable cost which is sensitive to the NPV. With 10% increase in variable costs, the NPV decreases by 63% whereas with a 10% decrease in sales, the NPV decreases only by 42%. Thus cost of capital is the most sensitive factor followed by variable costs and the least sensitive is sales.
Scenario Analysis
Under scenario analysis, different scenarios are taken where more than 1 input is altered and the impact of such changes is seen in the NPV. Normally there are three scenarios considered which is best case, normal case and worst case.
For the current situation, we have assumed the best case as increase in sales by 10%, decrease in variable costs by 10%, and decrease in cost of capital by 10%. For the worst case we have assumed decrease in sales by 10%, increase in variable costs by 10%, and increase in cost of capital by 10%. The results are as follows:
|
Original NPV |
Revised NPV |
% Change |
Best Case |
$13,885 |
$54,206 |
290.4% |
Normal case |
$13,885 |
$13,885 |
0.0% |
Worst case |
$13,885 |
-$11,504 |
-182.9% |
From the above table we see that the NPV increases by 290% in the best case and decreases by 183% in the worst case.
The risk and return analysis of Flight Centre Travel Group suggests that the stock is a safe stock with a beta less than 1 (0.92) and hence is a good investment for investors with low risk appetite. However, in order to maximize returns, it is suggested that the investor should invest in stocks of other companies with a beta of more than 1. This will diversify his portfolio. Also apart from stocks, he should invest in other securities like bonds and debentures.
The capital budgeting analysis of ABC Ltd. new plant expansion project gives a favourable result where the NPV is positive and the project seems favourable. Of all the inputs, cost of capital is the most sensitive factor.
Damodaran, A., (NA), Estimating Risk Parameters, Stern School of Business, New York
Finance. Yahoo, (2017), S&P/ASX 200 (^ AXJO), accessed online on 17th April, 2017, available at https://in.finance.yahoo.com/quote/%5EAXJO?ltr=1
Finance. Yahoo, (2017), Flight Centre Travel Group Limited (FLT.AX), accessed online on 17th April, 2017, available at, https://finance.yahoo.com/quote/flt.ax?ltr=1
To export a reference to this article please select a referencing stye below:
My Assignment Help. (2018). Risk And Return Analysis Capital Budgeting. Retrieved from https://myassignmenthelp.com/free-samples/risk-and-return-analysis-capital-budgeting.
"Risk And Return Analysis Capital Budgeting." My Assignment Help, 2018, https://myassignmenthelp.com/free-samples/risk-and-return-analysis-capital-budgeting.
My Assignment Help (2018) Risk And Return Analysis Capital Budgeting [Online]. Available from: https://myassignmenthelp.com/free-samples/risk-and-return-analysis-capital-budgeting
[Accessed 22 January 2021].
My Assignment Help. 'Risk And Return Analysis Capital Budgeting' (My Assignment Help, 2018) <https://myassignmenthelp.com/free-samples/risk-and-return-analysis-capital-budgeting> accessed 22 January 2021.
My Assignment Help. Risk And Return Analysis Capital Budgeting [Internet]. My Assignment Help. 2018 [cited 22 January 2021]. Available from: https://myassignmenthelp.com/free-samples/risk-and-return-analysis-capital-budgeting.
For years now, MyAssignmenthelp.com is providing affordable essay help to millions of students worldwide. Our essay assistance services have helped us in assisting students with even the toughest essay assignments. We take pride in the fact that we cater the best assistance to search terms like help me with my essay. We offer affordable services in the fastest way possible. For our fast delivering services, students trust us with their urgent essay assignment needs. Two of our most popular essay writing services are maths essay help and English essay help.
Answer: 1 (a) . In times of crisis, a contractual clause that is highly relevant is one that causes the early maturity of the debt, which is usually guaranteed by a mortgage, which, in short, can translate into an execution, also, anticipated of the latter. This early termination clause, which can also be called "acceleration clause". Currently, there are a number of laws and regulations of the states that govern the foreclosure process ...
Read MoreAnswers: 1. Decision usefulness is the important theory of financial reporting that emphasises on the individuals or group of individuals who use the financial information and their information requirements. This approach is adopted to fulfil the information requirements of the key users of financial reports. The primary users of such information are the investor and creditors. However, the usefulness of the financial information must not be ...
Read MoreAnswer: Introduction The report has been written to explore proposed business decision making for raising finance via equity or debt. X Company is trying to explore different venues of procuring funds and has surveyed and collected data regarding the cost of capital of the company under different structure and different level of risk. X company has an investment opportunity of $100,000 and for the purpose of the same the company has listed v...
Read MoreAnswer: Data to different managers in an organization: For presenting the interpretation of data used in the analysis, it is necessary to convey the same to various internal parties within the organization and the external parties as well. In this case, the data interpretation would be conveyed to the following three personnel and/or institution: 1. Supervisor: The supervisors tend to look after the profitability of a proposed project or in...
Read MoreAnswer: Repairing and maintenance expenses including fuel cost are allowed as deduction. The fuel bill as well as other vouchers supporting the expenditures must be properly maintained in order to get deduction for these expenses. Using quality control and management system will be helpful in controlling expenditures on wages, vehicles and telephone. The accountants should use clear and specific terms in the recommendation. No vogue words ...
Read MoreJust share requirement and get customized Solution.
Orders
Overall Rating
Experts
Our writers make sure that all orders are submitted, prior to the deadline.
Using reliable plagiarism detection software, Turnitin.com.We only provide customized 100 percent original papers.
Feel free to contact our assignment writing services any time via phone, email or live chat. If you are unable to calculate word count online, ask our customer executives.
Our writers can provide you professional writing assistance on any subject at any level.
Our best price guarantee ensures that the features we offer cannot be matched by any of the competitors.
Get all your documents checked for plagiarism or duplicacy with us.
Get different kinds of essays typed in minutes with clicks.
Calculate your semester grades and cumulative GPa with our GPA Calculator.
Balance any chemical equation in minutes just by entering the formula.
Calculate the number of words and number of pages of all your academic documents.
Our Mission Client Satisfaction
it was really good and i will recomend it to my friends. i got above average marks for it
Australia
Dear Sir/Madam, Thank you very much for your expertise and assistance. I was very informative and very helpful. Regards,
Australia
Dear Sir/Madam, Thank you very much for the excellent work! It really helped me a lot. Regards,
Australia
the best team ever and very timely manners with affordable pricing and won’t have any complaints
Australia