1. RECOMMENDATION:

The NPV is the capital budgeting technique that calculates the present value of net cash inflows that are generated by the project including its salvage value less the initial investment on the project. Since the NPV for the new machine is given to be -$ (24,076,710) and the NPV of old machine is given to be -$(10,805,263), so it seems to stick with old machine as it will cost less for the company. Although the new machine is saving 50% of the labor cost, still the incremental costs are more as compared to the benefits it might bring.

1. DIFFERENCES AND CHOICE:

The cost of new machine is $13,271,447 more than the old machine cost over next three years. This means that by installing new machine, the company will incur $13,271,447 extra cost given the rate of 9% WACC. It is recommended to the company to carry on with the older machinery as the NPV of cost is much lower for the older machine as compared to new machine.

Part B)

1. WACC increased by 1%

New NPV of Old Machine:

NPV	($10,612,130)

 

New NPV of New Machine

NPV	(23,840,333)

The NPV of new machine has fallen from $10,805,263 to $10,612,130 and the NPV of old machine has fallen to $23,840,333 from $24,076,710. This is because WACC is the rate that is used by the firms to discount the cash flows to find NPV. Both NPV and WACC are found to be inversely related, any increase in WACC will cause a reduction in NPV. This is because a higher interest rate means the company will have to set aside less today for earning a specified amount in future. With higher WACC, the projected cash flows will be discounted today at a higher rate, thus reducing the overall net present value and vice versa.

2. Base Rate Entity

If the firm enters into base rate entity, its tax rates are set to reduce to 27.5% for year 2019-2020. However, for the current scenario, the tax rate is already set at 27.5%, hence no changes will incur today. However, for 2020-21 and 2021-22 the tax rates will be 26.0% and 25.0%. Hence, following are the new NPVs on given new rates. Both NPVs have fallen with decrease in tax rates.

New NPV of Old Machine

NPV	($10,693,240)

New NPV of New Machine

NPV	(23,941,688)

 

3. Increase in Salary

With the increase in salaries by 5% annually, the NPV has risen for both the machines from $10,805,263 and $24,076,710 to $10,934,965 and $24,273,016 respectively. This is because the operational costs have risen and more cost is incurring in future to be discounted at 9%.

New NPV of Old Machine

NPV	($10,934,965)

New NPV of New Machine

NPV	(24,273,016)

 

4. Change in Sale Price of Old Machine

This will only affect the NPV of new machine to reach at $22,76,710 from $24,076,710. This reduction is because the initial investment has been lowered by further $1,500,000.

New NPV of New Machine

NPV	(22,576,710)

5. The All Four Effects

With all four effects i.e. change in sale value, increase in WACC, changes in Tax rates and increase in salaries, the NPV of new machine has fallen from $24,076,710 and the NPV of old machine has fallen from $10,805,263 to $10,627,139.

New NPV of Old Machine

NPV	($10,627,139)

New NPV of New Machine

NPV	(22,396,776)

 

6. Other Factors to Consider

The management can take into account the revenue streams, changes in tax regimes, changes in salaries, depreciation and other costs that are related to new and old machines while making decisions about which machinery to choose.

QUESTION 2:

1.  

Monthly Closing and Opening Prices of WOW

Months	Opening	Closing
January	27.17591	27.16182
February	27.14	27.2075
March	26.6995	26.7155
April	26.75316	26.83895
May	28.69522	28.64913
June	29.353	29.3935
July	30.75727	30.71182
August	29.26174	29.25435
September	27.9085	27.959
October	27.88583	27.96583
November	29.11381	29.1481
December	28.79737	28.83789

 

The rates are calculated by taking the average of day one opening price of month till last day opening price of month. For example, the first value is calculated by taking the average of the opening and closing values incurred in January.

Monthly Closing and Opening Prices of RIO

Months	Opening	Closing
January	56.03143	55.94857
February	55.84368	55.79316
March	52.00619	51.88429
April	53.98286	53.91
May	56.99545	57.01045
June	56.97381	57.02762
July	54.56286	54.61286
August	49.55043	49.45348
September	48.79684	48.74579
October	49.38609	49.22609
November	49.51714	49.60381
December	47.49722	47.29

 

The rates are calculated by taking the average of day one opening price of month till last day opening price of month. For example, the first value is calculated by taking the average of the opening and closing values incurred in January.

Monthly Closing and Opening Prices of All Ordinary Index

Months	Opening	Closing
January	6170.81816	6172.249978
February	6047.72002	6041.550024
March	6023.455029	6012.750024
April	5935.815764	5946.494706
May	6163.943508	6166.200025
June	6205.989966	6214.279981
July	6331.695468	6335.327282
August	6382.226096	6384.930431
September	6304.349951	6299.299951
October	6055.520813	6039.170817
November	5867.061895	5857.00951
December	5692.520996	5690.294691

The rates are calculated by taking the average of day one opening price of month till last day opening price of month. For example, the first value is calculated by taking the average of the opening and closing values incurred in January.

1. MONTHLY HOLDING RETURNS

RIO

Months	HDR %
January	4.00%
February	-2.67%
March	-2.96%
April	6.25%
May	3.62%
June	-3.28%
July	2.49%
August	-9.06%
September	9.72%
October	-3.14%
November	-6.74%
December	-0.58%

Holding Period Returns =  =  = 4.00%

Whereas, selling Price is closing price at each month.

WOW

Months	HDR %
January	0.37%
February	-1.06%
March	-2.63%
April	6.38%
May	2.41%
June	7.24%
July	-1.54%
August	-5.95%
September	0.67%
October	3.05%
November	1.47%
December	0.89%

Holding Period Returns =  =  = 0.70%

Whereas, selling Price is closing price.

All Ordinary Index

Months	HDR %
January	0.51%
February	-1.99%
March	-3.40%
April	3.45%
May	0.85%
June	2.71%
July	1.22%
August	0.97%
September	-1.59%
October	-6.32%
November	-2.98%
December	-0.69%

Holding Period Returns =  =  = 0.51%

Whereas, selling Price is closing price.

1. GRAPHS

 

1. STANDARD DEVIATIONS

	RIO	WOW	All Ord
Standard Deviation	5.27%	3.50%	2.67%

 

1. ANNUAL HOLDING RETURNS

	RIO	WOW	All Ord
Annual HDR	-0.20%	0.94%	-0.61%

F & G. COVARIANCES AND BETAS

	RIO	WOW
Standard Deviation	5.27%	3.50%
Covariance	0.04%	0.02%
Variance	0.28%	0.12%
Beta	0.153	0.196

RIO Beta =  =  = 0.153

WOW Beta =  =  = 0.196

1. CAPM MODELS

RIO

CAPM = Rf + β (Rm-Rf)

CAPM = 2.5% + 0.153 (-0.20% - 2.5%)

CAPM = 2.9131

WOW

CAPM = Rf + β (Rm-Rf)

CAPM = 2.5% + 0.196 (0.94% - 2.5%)

CAPM = 2.19424

1. INVESTMENT DECISION

As a rational investor, I will choose to invest in WOW because it has higher beta of 0.196 and higher holding return of 0.94% as compared to RIO which has a beta of 0.153 and the holding return of -0.20%.