Every company has capital projects. The company you have selected must need some

Question

Every company has capital projects. The company you have selected must need something! Be it a new wing to the building, a new product line to be funded, a new piece of equipment, find one new acquisition your company needs. Once you have identified the new possible investment item, what problems are you going to have in estimating the cash flow that might be emanating from the initial investment and problems in getting it funded? Issues might be: •Risk •Cost •Politics (getting it through committees) •Public Relations •etc., Identify a potential capital project for 3M, describe such a project and write a short summary of the problems you see in getting the funding to see it through.

Explanation / Answer

Solution -

We have a project to invest 2M intially with Uneven cash flow during the five years with the value of asset becomes zero after the life time of 5 years.

Looking at the project at 15% cost of capital the Project looks beneficial as per the NPV

Even using the Payback Period (PV) the project looks beneficial as shown below as it is able to recover the cost before the end of 5 years creating a benefit too

Payback Period = A + (!B!/C)

where

A = last period with a negative cumulative cash flow

B = absolute value of cumulative cash flow at the end of the period A

C = total cash flow during the period after A

Payback Period = A + (!B!/C) = 4 + 183908 / 298306 = 4.61 years

However the challenge here is the cost as we see the actual cash flow for year1 & year 2 = 550k each and if we llok at the yearly Payment for the Project finance we need to pay 596 k as annual payment which might make us ineligible for getting the finance.

however if the cost of capital is 10% we would be making Positive NPV with payback period as 3.94 years and the Annual repayment would be 527K which would be pad out of the cash flow of the initial year

There might be other risk like Cash Flow ( which should be collected as assumed and should not be lying in accounts receivable ) ,

Year Cash Flow 0 -2000000 1 550000 2 550000 3 750000 4 750000 5 600000

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