A city council has asked me to analyse and evaluate their financial proposal to host a pop music festival next summer that would take place on the sport field owned by the local university. The projected figures for hosting the event have been provided by the local council and they would like me to advise them, if the project is worth while pursing from a financial prospective. To establish whether the project is worth while pursing, I will use a number of financial analysising techniques and calculations to work this out, they will include using standard investment appraisal techniques.
For this investment appraisal I will attempt to use the current prices as pose to constant prices. Constant prices are the prices, that the council projected the figures to host the event the inflation at that time. I am going to adjust the net revenue by the current prices, which are the prices that I will predicate for each year. The Current price takes into consideration that inflation is changing every year. , therefore this needs to be accounted for. I will predicate my inflation rate (price levels) based upon the current inflation rate and economic climate for the year 2003.
The current inflation rate for November 2003 is about 2. 5% and the current economic climate is that most people think that we are entering recession due to the slow down of the global economy. If this is the case then my prediction that inflation over the coming years will be increasing, after about the year 2005 the inflation rate may start to decrease slightly and then on carry on declining. It must be stressed that these are anticipated inflation rates. I predicate the following inflation rate for the following years:
Year 2004 Inflation rate: 2. 7% (increase) Year 2005 Inflation rate: 2. 8% (increase) Year 2006 Inflation rate: 2. 8% (constant) Year 2007 Inflation rate: 2. 8% (constant) Justification for this assumption The UK has not joined the Euro and simplest will not in the future. The UK is under great pressure within joining the Euro. So it is anticipated that the UK will join the Euro in the near future, this will change the inflation and interest rate for this project completely.
The Euro interest rate is lower than the UK interest rate and their inflation rate is greater than the UK’s. For this appraisal I will make an assumption that they will not join the Euro in the near future years to come. The following spreadsheet shows the cash statement for the project, which show the in and out flows of the project, the net cash flow and the net cash flow adjusted to the anticipated inflation rate. Evaluation of Cash Statement From looking at the cash statement it is clear that in the first year that there is positive net cash flow.
This is because in the first year the council receives the bulk of the revenue from the event as they get sponsors from companies such as Coca-Cola, also from its advance selling of tickets. However the net cash flows for the following three years is negative as they are paying out. The payouts for the event are spread out over the 4 years, with the bulk of the money going out in the first 3 years that’s why in year 2005 and 2006 the net cash flow is largely negative as outflows are grater than inflows. Determination of Discount Factor
From the cash flow we are able to conclude that the organisers are in the public sector as pose to the private sector, because if the organiser were in the private sector then their cash flow would look different. Their net cash flow for the first year would be negative flowed by positive cash flow, as they would have initial outlay, grater than the revenue received in the first year. In this cash flow we have the opposite we have the positive cash flow followed by negative cash flow as they have an initial receipt, which is grater than expenditures for the first year.
Knowing that the organisers are in the public sector and have negative net cash flows after the first year due to their large payouts they have, the net cash flow has to be discounted at a higher factor. This is because by discounting the cash flow at a higher factor means the council can avoid the risk of not being able to pay out large sums they have in 2005 – 2007. To achieve a higher discount factor the discount rate has to be low, lower than the prevailing interest rate in the market. The higher discount factor will ensure that the council is able to pay out large sum , if they have too. The present Interest Rate value is 3. 75%.