BUSINESS FINANCE

Business Finance

Solution Consultants

MEMO

To:Mrs C. Partner

From: Mr. / Ms. Student

Re:Report for Client, Buckingham plc

CC: M. Trainer

Date: 20 February 2010

I will start by explaining some terms, theories, concepts and their usefulness, advantages and disadvantages. This will guide you through the report and will help in better understanding of the report presented here. Let me first present you with the concept of 'Hurdle Rate' as this is being used by your Finance Director for evaluation and decision making of future projects and existing divisions.

Hurdle Rate

The minimum acceptable rate of return, often abbreviated MARR, or hurdle rate is the minimum rate of return on a project a manager or a company is willing to accept before starting a project, given its risk and the opportunity cost of forgoing other projects.

For example, suppose a manager knows that investing in a conservative project, such as a bond investment or another project with no risk, yields a known rate of return. When analyzing a new project, the manager may use the conservative project's rate of return as the MARR. The manager will only implement the new project if its anticipated return exceeds the MARR by at least the risk premium of the new project.

The hurdle rate is usually determined by evaluating existing opportunities in operations expansion, rate of return for investments, and other factors deemed relevant by management. A risk premium can also be attached to the hurdle rate if management feels that specific opportunities inherently contain more risk than others that could be pursued with the same resources. A common method for evaluating a hurdle rate is to apply the discounted cash flow method to the project, which is used in net present value models. The hurdle rate determines how rapidly the value of the dollar decreases out in time, which, parenthetically, is a significant factor in determining the payback period for the capital project when discounting forecast savings and spending back to present-day terms.

When a project has been proposed, it must first go through a preliminary analysis in order to determine whether or not it has a positive net present value using the MARR as the discount rate. The MARR is the target rate for evaluation of the project investment. This is accomplished by creating a cash flow diagram for the project, and moving all of the transactions on that diagram to the same point, using the MARR as the interest rate. If the resulting value at that point is zero or higher, then the project will move on to the next stage of analysis. Otherwise, it is discarded. The MARR generally increases with increased risk.

Therefore, I have taken 14% as the hurdle rate for the evaluation of the New Projects as Market Portfolio rate is 11% and IRR for most of the existing divisions is 14%.

Table 1: NPV Calculation:

£

Construction

IT

Chemicals

year 0

(50,000,000)

(50,000,000)

(50,000,000)

year 1

14,733,333

17,500,000

11,840,000

year 2

14,733,333

17,500,000

11,840,000

year 3

14,733,333

17,500,000

11,840,000

year 4

14,733,333

9,995,000

11,840,000

year 5

14,733,333

9,995,000

11,840,000

year 6

14,733,333

9,995,000

11,840,000

year 7

-

-

11,840,000

year 8

-

-

11,840,000

NPV

$6,397,398.90

$5,518,491.40

$4,319,428.51

Assume:

DR 14%

Priority

1

2

3

For Construction Division, I have converted the Net cash flows from US Dollar to Pound Sterling according to the rate given, UK ...