Capital Budgeting and Investment Analysis

Discuss about the Sensitivity Analysis and Parametric Programming.

The managers have showed their interest in the project by taking into the consideration the long-term benefit, which is attached with the project. The managers of the project have targeted the impact, which will be on future because of increasing fuel prices and the steps, which the government should take in order to reduce the impact of the air pollution. In addition to this, the managers are inclined to use the subsidiary benefits, which have been offered by the government (Aalto 2012). The managers have also stated to use the waste material in the form of raw material for new venture, as this will form an additional cost saving benefit for the company. It is worth mentioning that among the several tools of capital budgeting available Net Present value and annual annuity method is considered as the best suited technique which the company can use to determine the long term viability of the project in the log-run. Such tools would help in evaluating the changes of key variables such as sales and price of ethanol depending upon the feasibility of the project (Channon and Jalland 2016). 

In order to understand the value of the project, the managers should perform breakeven so that it can meet the environmental requirement regarding the disposal of waste beer. Coors stated that he could be satisfied with breakeven only if the project would cut down the further VOC emission assisting them to avoid any probable fines. It is noteworthy to denote that the investment analysis commenced with the forecasting of future cash flows.

The incremental value for the project is to make pure fuel graded ethanol with incremental value of 5% of the gasoline, which must be added in contrast to the current price per gallon of gasoline. The managers have estimated that cost to be 15% of the revenue representing the incremental value of the project. The company anticipates it to be relatively stable for the next five years and this would for an approximate 20 cents per gallon of the ethanol. Rick on the other hand responded that the initial production capacity of 1.5 million is needed per year (Edwards 2013). The anticipated production for the initial year is 1.3 million of the gallon, which is anticipated to grow by 15% from the year 1994 to get 30% of the revenue per gallon and anticipated growth rate of 34% from the financial year of 1997 to 1998. The proposed production capacity with the current initial outlay should reach to two million gallon by the end of 1998. Being a joint venture Coors is aiming to realise a significant portion of debt by splitting the current portion of the revenue between Coors and Merrick in a ratio of 30/70. Splitting would enable Coors to realise 30% of the revenue per gallon of ethanol.

Quantitative Analysis: Sensitivity and Risk Assessment

Cost involved for the project consists of freight cost, which amounts to $300 per truck for number of 30 trucks per day. Cost also include 10% of the factory time in order to manage the processing of yeast (Horngren et al. 2013). The average wages, which will be incurred over production process, accounts for $9.33 per hour. On the other hand, as far as benefits are concerned an anticipated savings of $0.30 for transportation are more likely to be earned. Coors also anticipates revenue of 30% of the revenue per gallon with a benefit of 40 cents per gallon and a tax incentive of 51 cents per gallon would be add beneficial for ethanol production.

To analyse the appropriate opportunity cost of the project Coors should consider the weighted average cost of capital. Significant data were gathered to take into the consideration the weighted average cost of capital (Indounas 2014). The average market return for the project is estimated on the monthly data, which represented 12.6%. The estimation of the premium risk was based on the market risk where index data reflected 8.29% by taking into the consideration the inflation rate of 1991-1995 depending upon the consumer price index of 3.1%. Coors further planned to use this data to obtain a real discount rate so that it can discount the project’s cash flow. Furthermore, to evaluate the viability of the ethanol project the Weighted Average Cost of Capital along with the beta value of company should be considered to understand the viability of the project. This is because the Peter knows the beta value of the company. However, the WACC of pioneer group had been decided to evaluate and draw a comparable result with its competitor (Ittner and Michels 2015). The beta value of Great Plains is estimated to be 1.84 and the computations are based on the regression results performed for the last five months’ return of Coors. 

Depending upon the quantitative analysis Peter Coors optioned that the stewardship of the environment should be viewed as both personality responsibility as well as value for public. He went a step further by evaluating the quantitative as well as the qualitative aspects of the projects. By evaluating, the project based on the qualitative data by taking into the consideration the economic, environmental and social issues, which are concerned with the project (Morano and Tajani 2013). By undertaking the data obtained from the quantitative analysis it provides diversification of benefits of investments for the production of ethanol production. This is because the production of ethanol is not related to the production of beer. The study also reflects that undertaking the quantitative analysis ethanol additives would help in reducing the footprint of carbon in environment. This helps in promoting positive public relations for the company by being a good steward of the environment.

Qualitative Aspects and Diversification

In researching the ethanol prices, it has been discovered that the average whole price or in other words the rack price of ethanol during the last five years commencing from 1991-1995 was approximately around $1.20 per gallons. It is assumed that the current selling price of $1.35 per gallon of ethanol would fall down to approximate $1.20 per gallon. The assumption is relatively based on relative stableness for the next five years (Peters and Wieder 2015). On the other hand, the average demand for the ethanol will be based on the average factory wages. It is assumed that the aggregate factory worker wages is approximated around $9.33 and the Coors plans to use seven employees by dividing the shift into three eight-hour shift per day for distillation process of ethanol.

The sensitivity of the data is based on the projected market analysis as the entire estimation is based on the historical data. The data are collected for the computation of the required rate of return of equity. The sensitivity of the data is based on the average risk free rate for treasury bills of three month, which is estimated to be around 4.31%. Such data could be viewed as market risk as it is based on the assumptions of 1991 to 1995 with S&P index of 8.29% (Pratt 2013). The sensitivity of data is based on the average inflation rate from 1991 to 1995 depending upon the consumer price index of 3.1%. The sensitivity of the data is also based on the capital structure of the company with as the information of market structure values and interest rates of various type inflations.

In addition to the financial analysis qualitative factors forms the imperative part for any undertaking any project. In the current case study, qualitative elements consist of the environmental and social factors concerning the project. The managers have cited that the economic viability of the project seems to be well organised as it involves diversification. Project diversification for the current study consist of the benefits, which will be obtained from the investment made in the ethanol production (Horngren et al. 2013). It should be noted that the production of ethanol is not related to the business of beer production. Furthermore, certain illustrations of qualitative issues have also been highlighted in this project, which should not be ignored. As stated by John that VOC emission which contaminate air at the projected savings of $33.00 per “Tc” of carbon Dioxide provides ethanol with additional additives, which lowers down the carbon footprint of the environment. The qualitative measures help in establishing enhanced public relations for the organisation, which ultimately promotes a better stewardship of the environment.

Environmental and Social Factors

To conclude with the project regarding the perceived trade-off for doing well and doing good there were a large number of information that has been provided to perform the relevant projections concerning the project. Based on the certain information received a forecasted cash flow statement was pending to be prepared depending upon the information received for the project. Preparation of the forecasted cash flow would enable the managers of the project to produce the Performa of Income statement (Peters and Wieder 2015). After preparation of both the projected cash flow and income statement is prepared, the management need to decide the appropriate amount of beta value to be computed which would decide the feasibility of the project by reflecting the Weighted Average Cost of Capital. Once the discounted rate of figure is obtained from the computation, the management need to evaluate the feasibility of the ethanol projected by comparing the data or figure obtained from the current market projects. In addition to the above stated analysis, the management also need to perform the sensitivity analysis, which Peter has asked with Rick to derive certain data needed to assess the financial feasibility of the ethanol venture (Ittner and Michels 2015).

The managers could make the conclusion of investigating the data of sensitivity analysis, which would help in highlighting the changes to be made to the key variables in accordance with the several economic and operational perspective. This would enable the mangers to derive conclusion of the result obtained, which would form a key variable regarding the certain changes to be made in the variable inputs (Baucells and Borgonovo 2013).

Changes to the variable inputs consist of the demand for ethanol, current or prevailing conditions of the economic state, existing oil crisis, and increased level of competition from different alternatives of fuels along with the operational efficiency. It is evident from the project that the managers still need to perform several works but the overall assessment of the project provides that the production of ethanol is environmentally friendly keeping in view the sustainability of the project (Morano and Tajani 2013). The decision of making an investment in sustainability of the project allowed the managers to evaluate several business issues relating to the finance cost, accounting, management of operations and environmental management. The degree of reducing waste disposal cost and generation of revenues is the focus point concerning the project as it significantly provides the management of encouraging investment in environmentally safe projects.

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