Evaluating Investment Opportunities

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Evaluating Investment Opportunities

Part 1

BACKGROUND

Appropriately allocating financial resources is perhaps the most significant consideration in the field of finance. Capital budgeting is one of the central considerations that must be factored into the allocation process. Capital budgeting can be defined as the decision to make an investment based on the company’s financial resources.

Generating a return is the desired outcome of any investment. A company’s rate of return is determined by several factors including the length of the time required to attain the return, riskiness of the investment, and the dollar amount of the return. There are several types of capital investments for which companies can allocate their resources. Examples include maintenance projects, cost-saving projects, new business, and production enhancement.

INSTRUCTIONS

In your role as a senior financial analyst for Capital Financial, you are told the remaining budget to invest in a cost-saving project is $2.5 million. You have identified two opportunities that warrant in-depth analysis, and you will consider the cash flow from the following two projects (Project A and Project B) in your report.

  • Year 0
  • Project A: -750,000
  • Project B: -2,400,000
  • Year 1
  • Project A: 360,000
  • Project B: 1,700,000
  • Year 2
  • Project A: 420,000
  • Project B: 800,000
  • Year 3
  • Project A: 340,000
  • Project B: 850,000

After completing your analysis, write a formal business letter to the CEO and Board of Directors explaining your findings. Be sure to address the following:

  1. Calculate and include the IRR and NPV for the cash flows of both projects.
  2. Explain which project has the highest IRR and why this is important.
  3. Describe which project has the highest NPV and whether it is consistent with the IRR rule.
  4. Summarize the analysis of both projects, focusing on the pros and cons of each project, include your calculations for support in the business letter.
  5. Develop a persuasive argument using the calculations and data to support your recommendation for the project that should be pursued by the company.

Part 2

The insufficient management of credit risk primarily drove the subprime meltdown in the late 2000’s. Financial institutions issued loans to individuals and entities that lacked the income to meet their debt obligations. Further, many of the individuals/entities to whom loans were made were outside of standard parameters for creditworthiness.

  1. What are the consequences of firms failing to perform the proper due diligence to manage credit risk sufficiently?
  2. In your opinion, what would be the best financial metrics to identify credit risk?
  3. In your opinion, which stakeholder (firms, employees, shareholders, debt holders, or society as a whole) is most adversely impacted by the above conditions?

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