Mandatory assignment in IND500 Investment analysis This assignment must be submitted by Friday 16. October at 13.15, at Canvas. You may use Word, Adobe PDF and Excel format. Remember to mark your...

Mandatory assignment in IND500 2020 (1).pdf


Mandatory assignment in IND500 Investment analysis This assignment must be submitted by Friday 16. October at 13.15, at Canvas. You may use Word, Adobe PDF and Excel format. Remember to mark your answer with your name. Exercise 1 a) Describe briefly the Payback Period Method and compare its advantages and disadvantages. b) Setup a basic Operating Cash Flow (OCF) and explain the importance of OCF for a project analysis. c) Describe briefly the Dividend Growth Model (DGM). Exercise 2 You are considering a project in United Kingdom (A) and a project in Norway (B) and the two projects have the following cash flows (in million USD): Year 0 1 2 3 4 5 Project A -2 000 500 1 000 1 500 2 000 2 500 Project B -2 000 1000 1000 1000 1000 1 000 a) Both projects are believed to be risk-free. Calculate the net present values (NPV) for the two projects using a risk free discount rate of 5%. If you have access to sufficient capital, should both projects be executed? Which project would you prefer if it is only possible to finance one of the projects? b) New information about project A reveals that it is risky. A discount rate of 15% is proposed by an investment expert. What is the risk term of the new discount rate? Recalculate the NPV of project A. Should both projects be executed if you have sufficient capital? What is the preferred project? c) What is the internal rate of return (IRR) of the two projects? Should the IRR be compared directly for these two projects? Exercise 3 The company Surf Stavanger is starting a new business in Stavanger, selling lessons for stand up paddling at Stokkavannet. So far, the company has invested 1 million NOK in market research and marketing, and needs to invest a further 3.0 million in equipment to become operational. Their market report indicate that people are willing to pay 1 200 NOK an hour for paddling lessons. They estimate that they can sell a 3 hour course 3 times a week with an average of 10 participants at each course. With operations in 40 weeks a year the total number of hours sold is 3 600 a year. The project is considered for a 5 year period, starting from next year, and you can assume a straight line depreciation with zero salvage value. The cash flow will be the same for each year, i.e. no growth in the operational cash flow. Below is a summary of the variables: Variable Value Unit Market Research 1000000 NOK Investment in Equipment 3 000 000 NOK Sales Price 1 200 NOK/hour Variable cost 250 NOK/hour Fixed costs 1 200 000 NOK/year Annual Production 3 600 Hours Project Life 5 Years Salvage Value 0 NOK Discount Rate 10 % Tax rate 25 % OCF growth rate 0 % a) Set up the project's cash flow and calculate the Net Present Value (NPV) by assuming a discount rate at 10%. Should Surf Stavanger make the investment? b) The annual production of 3 600 hours a year is an optimistic estimate, and Surf Stavanger wants to estimate a pessimistic scenario. In this scenario, they estimate a sales price of 800 NOK/hour and selling only 2 800 hours a year. Calculate the expected NPV if there is a 50% chance for both the optimistic and the pessimistic scenario. Surf Stavanger is considering using a new environmental friendly technology for the paddle board which will reduce the variable cost with 50%. With this board, Surf hope to increase their chances of the optimistic scenario to 75%, leaving a 25% chance for the pessimistic scenario. The technology comes at a price, and Surf needs to invest an additional 1 million to make the board functional. c) Use a decision tree and make necessary calculations to estimate what alternative is most profitable (existing paddle board or new technology). d) Are there other considerations that may affect the decision in (c)?