Professional Documents
Culture Documents
ON
CASE RELATED TO CAPITAL BUDGETING AND PROBABILTY DISTRIBUTION
CASE ANALYSIS
OF UNIVERSITY CITY
LOUNGE
Submitted to:
Md. Enamul Haque Assistant Professor United International University
Prepared by:
Suzona Asad S.M. Sakib Mahim Iqbal Jagirdar Ismat Jerin Chetona 111 081 149 111 081 205 111 081 166 111 082
Introductory Part
Segment Objectives
This section will focus on:
April 26, 2011 Md. Enamul Haque Assistant Professor Course Name: Corporate Finance Course Code # BUS 2112 United International University Dhanmondi, Dhaka. Dear Sir Subject: Submission of Report on Case Study Related to Capital Budgeting and Probability Distribution With due respect and humble submission, we student of BBA, spring 2011 are submitted the report on Case Study Related to Capital Budgeting and Probability Distribution. It gives us immense pleasure to inform you that we have completed this report under your kind hearted direct supervision. Now we have placed this report before you for your approval. We hope that our report will satisfy you.
Sincerely yours, ___________ Suzona Asad ID # 111081149 (On the behalf of)
Acknowledgement
At first we would like to thank almighty God for helping us all the way, and then Bachelor of Business Administration (BBA) for having such a wonderful and unique course, through which we get chance to know about the implication of Corporate Finance. We would like to give special thanks to our honorable instructor Md. Enamul Haque for giving us the great chance to report on this kind of important topic. And he has helped us from time to time on different issues regarding the case study & preparation of report. During the preparation of the report, we had some problem that had been erased out with his propound lecture and assistance. Without his cooperation and guideline this report would have been an incomplete one We would like to thanks the United International University for helping us all the time and in all the way. And we would like to convey our thanks to our one of the faculties Moshtafa Monzur Hasan who has helped us a lot to solve this problem. And without his support, we will not be able to solve this case. We would like to convey our thanks to one of our faculties Jinea Akhter who has assisted us in every possible ways. We also appreciate the unity, spontaneous workability and successful team spirit of our fellow group members/friends. Without cooperation and support from each other, it would not be possible to prepare a resourceful report.
Table on Contents
Parts Executive summary INTRODUCTION Objective Scope Limitation Methodology Types and Sources of Data Data Collection Plan Data Analysis Plan 2. WHAT IS GLOBAL WARMING? History Global Warming and Bangladesh at a Glance What is Green House Effect
02 03 05
Effects of Global Warming Causes of Global Warming Impact of Global Warming on Bangladesh
2.8
Effect of global warming on soil and land resources in Bangladesh Consequences Warming of Global
14
2.9
15
2.10
What we can do to reduce 16 global warming 17 Solutions and Technology 19 CONCLUSION AND RECOMMEDATION 21 REFERENCE
2.11 3.
EXECUTIVE SUMMARY
University City Lounge is a lounge that is located in the college community of Claremont, Pennsylvania, about 65 miles north of Pittsburgh. The case study is related to the University City Lounge, which is operated by Richard James. In this case, it has been seen that the owner of the lounge has two mutually exclusive projects, Conventional set and Video-projector. These two projects are having different initial investment and different and different returns. We have shown various financial analyses for the selection of any one of them. The objective of this report is to know about the real scenario of financial condition, to know how to implement different financial tools. For completion of this report, we have used only secondary data. And there are some limitations in this report that is mainly because of the limitation of information. But we have tried to give our 100% effort to prepare this report.
Report Preliminaries
Segment Objectives
This section will focus on:
Origin of the report Scope of the report Rationale of the study Objectives of the study Methodology of the study Limitation of the study
10
The primary objective of this case report is to analyze the critical issues and pros and cons of University City Lounge. The objectives can be more specifically stated as:
To To To To
get an idea about the Capital Budgeting Decision enable to apply the concepts in financial decision making. know how to link various complex situation. increase our analytical ability.
Apart from this, the case study also has following objectives: Identification of the problem or problems Identification of the alternative courses of action Critical Analysis; both qualitative and quantitative Provide Recommendation
1.5: Methodology:
This case report is an analytical report in nature. Data Collection: The organization part of the report is mainly based on the secondary data provided in the case. Assumptions: As there was no scope for acquiring data from outside sources, some realistic assumptions have been considered for missing information. Data Analysis: We have analyzed the data from the perspective of Qualitative Judgments: In the qualitative analysis, we provide theoretical aspect of Budgeting Decision. We conduct economy analysis, Industry analysis, and Company analysis. In company analysis we put emphasis on SWOT analysis. Apart from this we also analyze financial history of the company, business risk, and financial risk. Quantitative Appraisal: The data was analyzed with simple financial tools like Net Present Value (NPV) approach, profitability index. In quantitative analysis, we deal with the problem of the case and analyze some focusing point of the case.
11
Language: Abstract terminology and technical terms have been avoided as much as possible so that any person can understand the theme of the case report.
12
Conceptual framework
Segment Objectives
This section will focus on:
Capital Budgeting Different investment decisions: Techniques of capital budgeting and their acceptance criteria Different situation analysis
13
Introduction
Segment Objectives
This section will focus on:
Overview of University City Lounge Formation of University City Lounge Investment Strategy of University City Lounge Problem Statement Alternative courses of actions
14
Introduction:
Capital budgeting is one of the most important tasks faced by financial managers. A firms capital budgeting decisions define its strategic direction, because moves into new products, services, or markets must be preceded by capital expenditures. Capital budgeting is very obviously a vital activity in business. The results of capital budgeting decisions continue for many years. Vast sums of money can be easily wasted if the investment turns out to be wrong or uneconomic. In the case University City Lounge, we have applied various tools of capital budgeting to determine whether the owner of University City Lounge invest in the Conventional set or in the Video projector.
University City Lounge a small corporation in the college community of Claremont, Pennsylvania. It is primarily a university-oriented city. University City Lounge (UCL) operate by Richard James founded five years ago in down town section of the city. University City Lounge (UCL) growth opportunity is 10 percent each year. James owns all the stocks of UCL. The firm has no outstanding debt. University City Lounge (UCL) mainly appealing to students in general and young adults. The room of the business contains ten tables that seat four persons each and five large booths capacity is six 15
persons each. Also there is a separate game room. There are five tables that seats 20 customers. The third area within UCL is situated to the right of the central drinking space. Also there is a bar house in the T.V. lounge and right now UCL T.V. is not working. So this time James going for two mutually exclusive investment project. (1) A conventional color set with a 25-inch screen or (2) a product called video-projector, which is offers a 24-square-foot (6 feet high by 4 feet wide). James tax matters handle by Danial Ruggins. He and James began to develop the data necessary for making an effective choice between the two televisions. First project costs $700 fixed and other inventory costs is $200. Second project $3800 including set-up costs. James would add 6 tables at a unit cost of $30 and 24 chairs at unit costs of $10 and additional assets costs is $300. The assets of UCL were always depreciated using the straight-line method. They estimated UCL will get 218 customers daily and their seating factor is 1.5 times. James operates UCL on all 365 days of the year. Last year, UCL earned $24,371 after taxes, sales were $358,000, Cost of goods sold was $187,592 and last year their tax was 29.1 percent. Now current tax rate is 34 percent. UCL is expecting adding one extra customer in their lounge which increased their annual sales $1643. UCL is thinking two different types of probability in terms of their project. James and Ruggins are now considering one of the projects from two.
The owner of University City Lounge has decided that they are having two mutually exclusive projects. First one is the conventional set and second one is the video projector.
We can determine whether the investment should made in Conventional set or in Video projector by using both qualitative and quantitative approaches. The quantitative approaches include: Net Present Value (NPV) approaches Profitability Index Probability distribution Standard deviation
Segment Objectives
This section will focus on:
18
Analytical Part
Segment Objectives
For complete, rational and prudent study, we divide the analysis into two broad classes:
Analysis
Qualitative Analysis Economy Analysis Industry Analysis Company Analysis Risk Analysis
19
Qualitative Analysis
Segment Objectives
This section will focus on:
Economy Analysis:
20
The city has never faced depression. The city has diversified and sound industrial base. Other restaurant has the capability to buy a high priced video projector.
5.3: Company Analysis:
SWOT Analysis
Strengths High Sales volume: High growth rate Location Environment Sales in last year was proximate $24371 The growth of the net profit is 10% Located in a sound industrial based area. The lounge is having three separate environments, dining area, game room and lounge. Weaknesses Its located about 65 miles north of Pittsburgh One owner
Opportunities The city gas never faced depression. The owner has a good personal relationship with several local bankers. 21
Threats The tax rate was 29%, but now its go to be 34% There is an uncertainty that whether the video projector or the conventional set will be profitable.
Due to the existence of the above uncertainties, it can be said that University City Lounge is going to invest in a risky projects. In our analysis throughout the report we have considered different scenarios. This includes: For Conventional set, the optimistic situation has been determined. For conventional set, the demand has been decided based on probability distribution For Video projector, the seating-factor has been considered. For video projector, the probability distribution had been used. All the situations have been determined by using various discounting rates, because the discounting rate is not certain here. Risk Analysis- Base case: After Tax cash flow:
22
Apart from this we have used: Sensitivity analysis Scenario analysis Simulation analysis
budgeting
technique:
Analysis
of
Bailey
23
Project Financing
Segment Objectives
This section will focus on:
Financing the project Hamada equation Optimum capital structure Analysis of bailey prospect
24
In this case, we have assumed that the firm will either use its own capital money, or it will use 50% debt and 50% equity.
Calculation of risk free rate and required rate of return: in the case, the after tax risk-free rate is 5% it has been assumed that the cost of debt is 10% and the required rate of capital is 12%, we have assumed that the risk-premium is 7% when the risk is comparatively lower and the risk premium is 10% when the risk is comparatively higher.
Required rate of return calculation: According to Capital Asset Pricing Model: r= RF+ (RM-RF) Here, risk-free rate=5% =1 (Considering average capital market) Risk premium is 7% r = 0.05+ 1*0.07 25
=12%
Comparative qualitative analysis of Conventional set and Video projector. Conventional set is colorful and 25 inch. Video projector is 24 square feet and having clear image. Video projector is more costly than that of the conventional set. There is possibility that the conventional set can be bought by other lounges.
Main part:
Considering 12% required rate of return, and 34% tax-rate, NPV of Conventionalset: (when the situation is optimistic)
out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation
26
47.6
47.6
47.6
47.6
47.6
Required rate of return calculation: According to Capital Asset Pricing Model: r= RF+ (RM-RF) Here, risk-free rate=5% =1 (Considering average capital market) Risk premium is 10% r = 0.05+ 1*0.10 =15%
r wacc = S/B+S (rs) + B/B+S (rb) (1-T) = * 0.12+ * 0.10 (1-0.34) =9.3%
The risk of the Lounge may increase, that time the required rate of return may increase. So considering higher risk, we have assumed that the required rate of return is 15%
year-1 out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield 700 200 2.142 1.41372 516.0078 140 47.6 Year-2 0 0 2.142 1.41372 516.0078 140 47.6 year-3 0 0 2.142 1.41372 516.0078 140 47.6 year-4 0 0 2.142 1.41372 516.0078 140 47.6 year-5 0 0 2.142 1.41372 516.0078 140 47.6
27
profitability index
2.150912222
year-1 out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is 700 200 2.142 1.41372 516.0078 140 47.6
profitability index
2.441830294
Year-2 0 0
year-3 0 0
year-4 0 0
year-5 0 0
28
before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is
profitability index
2.711252024
= 215.2092
Cumulative probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
Profitability index 2.295765686 2.295765686 2.295765686 2.295765686 2.295765686 2.295765686 2.295765686 2.295765686 2.295765686 2.295765686
Profitability index based on probability distribution 0.229576569 0.459153137 0.688729706 0.918306274 1.147882843 1.377459412 1.60703598 1.836612549 2.066189117 2.180977402
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0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
2.150912222 2.150912222 2.150912222 2.150912222 2.150912222 2.150912222 2.150912222 2.150912222 2.150912222 2.150912222 2.441830294 2.441830294 2.441830294 2.441830294 2.441830294 2.441830294 2.441830294 2.441830294 2.441830294 2.441830294 2.711252024 2.711252024 2.711252024 2.711252024 2.711252024 2.711252024 2.711252024 2.711252024 2.711252024 2.711252024
0.215091222 0.430182444 0.645273667 0.860364889 1.075456111 1.290547333 1.505638555 1.720729778 1.935821 2.043366611 0.244183029 0.488366059 0.732549088 0.976732118 1.220915147 1.465098176 1.709281206 1.953464235 2.197647265 2.319738779 0.271125202 0.542250405 0.813375607 1.08450081 1.355626012 1.626751214 1.897876417 2.169001619 2.440126822 2.575689423
30
Pessimistic situation
Considering 15% required rate of return:
out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is 700 200 0.700434 0.46228644 168.7345506 140 47.6 0 0 0.700434 0.462286 168.7346 140 47.6 0 0 0.700434 0.462286 168.7346 140 47.6 0 0 0.700434 0.462286 168.7346 140 47.6 0 0 0.700434 0.462286 168.7346 140 47.6
900 -128.2925265
31
profitability index
0.857452748
out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is
0.70043
0.46228
168.734
14 47
profitability index
0.904814869
Year-1 out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield 700 200 0.700434 0.46228644 168.7345506 140 47.6
32
profitability index
0.958224053
out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is
profitability index
1.04068
Standard deviation:
Mean= 846.2645 Standard deviation=70.71548
Pessimistic
33
cumulative probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
profitability index 0.857452748 0.857452748 0.857452748 0.857452748 0.857452748 0.857452748 0.857452748 0.857452748 0.857452748 0.857452748
out come 0.085745275 0.17149055 0.257235824 0.342981099 0.428726374 0.514471649 0.600216924 0.685962198 0.771707473 0.814580111
cumulative probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
profitability index 0.904814869 0.904814869 0.904814869 0.904814869 0.904814869 0.904814869 0.904814869 0.904814869 0.904814869 0.904814869
Out come 0.090481487 0.180962974 0.271444461 0.361925948 0.452407435 0.542888921 0.633370408 0.723851895 0.814333382 0.859574126
cumulative probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9
profitability index 0.958224053 0.958224053 0.958224053 0.958224053 0.958224053 0.958224053 0.958224053 0.958224053 0.958224053
Out come 0.095822405 0.191644811 0.287467216 0.383289621 0.479112027 0.574934432 0.670756837 0.766579242 0.862401648
34
0.95
0.958224053
0.91031285
cumulative probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
profitability index 1.04068 1.04068 1.04068 1.04068 1.04068 1.04068 1.04068 1.04068 1.04068 1.04068
Out come 0.104068 0.208136 0.312204 0.416272 0.52034 0.624408 0.728476 0.832544 0.936612 0.988646
35
Video-projector:
Year-2 0
year-3 0
year-4 0
year-5 0
Year-1 out flow Outflow Out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation 3800 300 180 240 3.0536352 2.015399232 735.6207197 844
Year-2 0
Year-3 0
Year-4 0
Year-5 0
36
286.96 3721.331278
286.96
286.96
286.96
286.96
out flow Outflow Out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is For 5 years the outflow is NPV of the project is Profitability index
Video projector year-1 3800 s 180 240 3.0536352 2.015399232 735.6207197 844 286.96 3893.203861 4520 -626.796139 0.861328288
Year-2 0
year-3 0
year-4 0
year-5 0
37
year-1 out flow Outflow Out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is For 5 years the outflow is NPV of the project is Profitability index 3800 300 180 240 3.0536352 2.015399232 735.6207197 844 286.96 $4,204.32 4520 ($315.68) $0.93
Year-2 0
year-3 0
year-4 0
year-5 0
Mean:
$3,842.88 Standard deviation 278.19592
Cumulative Probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
Profitability index 0.79 0.79 0.79 0.79 0.79 0.79 0.79 0.79 0.79 0.79
outcome 0.079 0.158 0.237 0.316 0.395 0.474 0.553 0.632 0.711 0.7505
38
Cumulative Probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
Profitability index 0.861328288 0.861328288 0.861328288 0.861328288 0.861328288 0.861328288 0.861328288 0.861328288 0.861328288 0.861328288
outcome 0.086133 0.172266 0.258398 0.344531 0.430664 0.516797 0.60293 0.689063 0.775195 0.818262
Cumulative Probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
Profitability index 0.93 0.93 0.93 0.93 0.93 0.93 0.93 0.93 0.93 0.93
outcome 0.093 0.186 0.279 0.372 0.465 0.558 0.651 0.744 0.837 0.8835
39
1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1 2 3 4 5 6 7 8 9 10 Series1 Series2 Series3 Series4
Year-1 out flow Outflow Out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield 3800 300 180 240 77.112 50.89392 18576.2808 844 286.96
year-2 0
year-3 0
year-4 0
year-5 0
40
$63,512.96
out flow Outflow Out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is
3800 300 180 240 77.112 50.89392 18576.2808 844 286.96 $68,205.72
Year-1 out flow Outflow Out flow out flow before tax income After tax income (for 1 day) 3800 300 180 240 77.112 50.89392
Year-2 0
Year-3 0
Year-4 0
Year-5 0
0 77.112 50.89392
0 77.112 50.89392
0 77.112 50.89392
0 77.112 50.89392
41
After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is For 5 years the outflow is NPV of the project is Profitability index
year-1 out flow Outflow Out flow out flow before tax income After tax income (for 1 day) After tax income (for 1 year) Depreciation Depreciation tax shield For 5 years the inflow is 3800 300 180 240 77.112 50.89392 18576.2808 844 286.96 $81,667.96
year-2 0
year-3 0
year-4 0
year-5 0
42
Mean
$71,581.33
Standard deviation
7747.59895
Current seating factor Cumulative Probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95 Profitability index 14.05 14.05 14.05 14.05 14.05 14.05 14.05 14.05 14.05 14.05 Outcome 1.405 2.81 4.215 5.62 7.025 8.43 9.835 11.24 12.645 13.3475
43
Cumulative Probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
Profitability index 16.14 16.14 16.14 16.14 16.14 16.14 16.14 16.14 16.14 16.14
Outcome 1.614 3.228 4.842 6.456 8.07 9.684 11.298 12.912 14.526 15.333
Cumulative Probability 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 0.95
Profitability index 18.07 18.07 18.07 18.07 18.07 18.07 18.07 18.07 18.07 18.07
Outcome 1.807 3.614 5.421 7.228 9.035 10.842 12.649 14.456 16.263 17.1665
44
45