Cash flows

The 7 year projections of Dargdaffin’s Enterprises Plc. cash flows indicate that the new operating plant that will allow it to develop the prototype for its Shooting Star golf ball range will maximize the firm’s value. This decision is further confirmed by the net present value calculated for the company. Net present value (NPV) is defined as the sum of the present values of the annual cash flows minus the initial investment (Source- Fundamentals of Corporate Finance, Third Edition, by Brealey, Myers & Marcus).

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If the NPV of all cash flows is positive, the project will be profitable. The NPVs for Dargdaffin’s Enterprises Plc project is advisable, since it has a positive NPV of i?? 105,046. 46 if it’s valued at 15%, for 16% its NPV will be i?? 68,246. According to Appendix-B the NPV of the project is falling if the rate of interest is increased. The Internal Rate of Return (IRR) is another business tool used for capital budgeting decision. The discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero.

Generally speaking, the higher a project’s internal rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first. IRR is sometimes referred to as “economic rate of return (ERR)”.

(Source- http://www. businesscase. com/html/pro_forma. html), as the project is generating 17.81% which is greater than the required one the project is worthwhile to invest in. Both NPV and IRR analyses support the investment in project. The Modified Internal Rate of Return (MIRR) is yet another criterion for capital budgeting decision. While the Internal rate of return (IRR) assumes the cash flows from a project are reinvested at the IRR, the modified IRR assumes that all cash flows are reinvested at the firm’s cost of capital. Therefore, MIRR more accurately reflects the profitability of a project.

(Source- http://www. businesscase. com/html/pro_forma. html) Again, the MIRR supports if the project is undertaken. As per the Dargdaffin’s Enterprises Plc’s project I have assumed the reinvestment rate is 15% and financial rate is taken as 15% which gives a MIRR for the project is 16. 28% which somewhat near to NPV. The payback period represents the amount of time that it takes for a capital budgeting project to recover its initial cost. If the project is undertaken it would pay back the initial cost in 4.

95years which is derived from Appendix A. Thus, Dargdaffin’s Enterprises Plc. should accept the project as its meeting all the stated requirements and also generating positive NPV as NPV is the best method as can be found after reading the merits which is stated below. Merits of Dargdaffin’s investment appraisal system Investment decisions are very important to a business because it involves making an expense of something of economic value, usually cash, which the outlay precedes to benefits.

If a wrong decision is made, the effects would be very negative. Dargdaffin’s has used traditional investment appraisal system as well as alternative appraisal systems just to overcome negative sides of NPV,IRR,MIRR and Discounted payback periods and get best possible results. Using the above equation the theoretical ex-rights price and the value of a right based on the closing trade price on 6th November 2007 was the detailed calculations please refer on Appendix D answer is 0. 20p.

And also the illustration on if the investor owes 1,000 shares how the investor is unaffected even though if he/she takes up or sells the rights is shown in Appendix E and also the calculation of Principle wealth of the investor is on shown in Appendix E how the investor doesn’t get affect even though he/she takes up the rights or sells the rights. Capital structure theory Capital structure is the mixture of sources of funds a firm uses (debt, preferred stock, common stock). The amount of debt that a firm uses to finance its assets is called leverage. A firm with a lot of debt in its capital structure is said to be highly levered.

A firm with no debt is said to be unlevered. (Source – www. moneyterms. co. uk) . Capital structure theory is assumed to be most puzzling issues in the corporate finance literature from many years and still remains as the same as there are numerous observed studies has shown that announcements of seasoned equity offerings (SEOs) cause negative price reactions on the market, whereas the news of an additional debt issue is followed by an increase in stock prices. The majority of these studies use capital structure arguments emphasizing the importance of tax shield benefits from debt financing, as the explanation for this phenomenon.