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Npv Projections from Capital Expenditures

Essay by   •  February 19, 2012  •  Case Study  •  332 Words (2 Pages)  •  3,197 Views

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To: Bob Prescott

From: Capital Expansion Analysis Team

Date: Tuesday February 14, 2012

Subject: NPV Projections from Capital Expenditures

The following information details the analysis and projections of the proposed acquisition of the new onsite longwood woodyard. This project will allow the firm to eliminate excess cost from middlemen and suppliers as well as provide another market for Worldwide Paper to access customers. Accordingly, we expect to generate sales of $10 million within three years and maintain that rate for the life of the project. The firm's weighted average cost of capital is 9.66%, with a large portion of the weighting coming from common equity. Based on revenue and cost savings projections, we expect to generate an NPV of $829,222. This project will generate an internal rate of return of 11.07%. The breakeven revenue for this project after the first year is $7,889,286.

Risks include an inaccurate projection of the date from a variety of standpoints. In order to better understand the risks of erroneous data, a sensitivity analysis of several key factors is presented below.

The WACC appears to be sensitive to small changes in its estimate. A misrepresentation of the company's current capital structure or any changes in the future capital structure should be closely monitored. The company currently discounts its projects at 11.07%, however; even a one percent rise in the cost of capital will result in a negative NPV.

Cost of Goods Sold as a percentage of sales also appears sensitive to small changes. If COGS rises to 80% of sales, the present value will be negative and the internal rate of return will be below the discount rate. As a precautionary measure, it is recommended that the company keep a close watch on managing expenses and avoiding waste in our operations.

After careful analysis, it is the recommendation of this team to pursue this capital expenditure project. Special risks to watch include consistency in the firm's capital structure as well as close management of the firm's cost of goods sold expenses.

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