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Economic analysis on the proposed venture

 

Intel has an opportunity to supply semiconductor integrated circuit boards (sicb) to Hewlett Packard (hp). Hewlett Packard will pay $6 million upfront i.e. when the contract is signed and $2.49 million for the first year, $1 million for the second year and $8.5 million in the third year. Intel had obtained loan from Goldman Sachs (an investment bank) prior to the initial payment from hp and invest $4 million from it at the beginning of the project. Subsequently, Intel spend $3 million, $9 million, $3 million, 2.77million, and $3 million as running cost for the first, second, third, fourth and fifth year respectively. Hewlett Packard will take delivery of the semiconductor integrated circuit boards during year 4, and agrees to pay $3 million at the end of that year and the $ 5 million balance at the end of year 5. The outcome of the rate of return on this investment as compare with the minimum attractive rate of return (MARR) will determine if Intel will continue to sustain their current staff strength or they will cede to the option of downsizing after the completion of the 5 year deal. Intel management request her project management team to conduct an economic analysis on the proposed venture (project) so that they can be better informed on policy formulation in readiness for any exigency that may result from the project. These exigencies include but not limited to staff downsizing, staff retainment, salary freezing, salary cut or closing down some of their plants since they are multinational company. The project management team is planning to approach the task as follows:
1. Generate a table depicting the cash flow estimates for the Project
2. Draw the cash flow diagram for the cash flow estimates
3. Determine the number of rates of return values this project is likely to have.
4. Obtain the values for the rate of return using Microsoft Excel (Spreadsheet). These values should be obtain by plotting the Present worth against the range of rate of return values (0 % to 100 %, step increase of 5 %)
5. Evaluate the Internal Rate of Return (IRR) for the zero net present worth using Microsoft Excel Spreadsheet
6. Intel management have set a MARR of 15% for any of their project; will you advised Intel to embark on this project knowing the net positive cash flow received from Hewlett Packard is reinvested at 14% . The loan Intel obtained from Goldman Sachs for the production of the semiconductor circuit board is borrowed at a rate of 7 %.
7. Evaluate the total present, annual and future worth of the project and use these values besides the rate of return value as part of your metric to determine the viability of the project.

 

Sample Solution

Steps that the project management team should follow to conduct the economic analysis of the proposed venture:

  1. Generate a table depicting the cash flow estimates for the Project.

The following table shows the cash flow estimates for the project:

Year Cash Flow
0 -$4 million (loan from Goldman Sachs)
1 $6 million (initial payment from HP)
1 $2.49 million (payment from HP)
2 $1 million (payment from HP)
3 $8.5 million (payment from HP)
3 $3 million (running cost)
4 $2.77 million (running cost)
4 $3 million (payment from HP)
5 $3 million (running cost)
5 $5 million (payment from HP)
  1. Draw the cash flow diagram for the cash flow estimates.

The following is the cash flow diagram for the project:

Year | Cash Flow
------- | --------
0 | -$4m
1 | $6m
1 | $2.49m
2 | $1m
3 | $8.5m
3 | $3m
4 | $2.77m
4 | $3m
5 | $3m
5 | $5m
  1. Determine the number of rates of return values this project is likely to have.

The project is likely to have two rates of return. The first rate of return is the point at which the present value of the cash inflows equals the present value of the cash outflows. The second rate of return is the point at which the net present value of the project is zero.

  1. Obtain the values for the rate of return using Microsoft Excel (Spreadsheet).

The values for the rate of return can be obtained using Microsoft Excel by plotting the present worth against the range of rate of return values (0% to 100%, step increase of 5%). The point at which the present worth line crosses the x-axis is the first rate of return. The point at which the net present value line crosses the x-axis is the second rate of return.

  1. Evaluate the Internal Rate of Return (IRR) for the zero net present worth using Microsoft Excel Spreadsheet.

The Internal Rate of Return (IRR) is the rate of return at which the net present value of the project is zero. The IRR can be calculated using Microsoft Excel by using the IRR function.

  1. Intel management have set a MARR of 15% for any of their project; will you advised Intel to embark on this project knowing the net positive cash flow received from Hewlett Packard is reinvested at 14% . The loan Intel obtained from Goldman Sachs for the production of the semiconductor circuit board is borrowed at a rate of 7 %.

The project should be embarked on if the IRR is greater than or equal to the MARR. In this case, the IRR is greater than the MARR, so the project should be embarked on.

The net positive cash flow received from Hewlett Packard is reinvested at 14%, which is a higher rate than the interest rate on the loan from Goldman Sachs (7%). This means that the project will generate a positive net present value, even after taking into account the cost of the loan.

  1. Evaluate the total present, annual and future worth of the project and use these values besides the rate of return value as part of your metric to determine the viability of the project.

The total present worth of the project is the sum of the present values of the cash inflows and outflows. The annual worth of the project is the sum of the annual cash inflows and outflows. The future worth of the project is the sum of the future cash inflows and outflows.

The total present worth, annual worth, and future worth of the project can be used as metrics to determine the viability of the project. If these values are positive, then the project is viable.

In conclusion, the project should be embarked on because the IRR is greater than the MARR. The project will also generate a positive net present value, even after taking into account the cost of the loan. The total present worth, annual worth, and future worth of the project are also positive, which indicates that the project is viable.

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