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please find attached case study for our homework we would like to hear your respond

with most clarification not only numbers as introduction and conclusion also required (full summary )

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Financial Management Analysis
Case Study 2) Capital budgeting, and CAPM
Case Study:
The Shell Company plans to expand its capacity and growth through the acquisition of a new
Drilling machine which is expected to add value in the company. Making a valuation on capital
investment is a standard process. The general management needs to evaluate the two drilling
machines as alternative purchases, to replace an old one. Being in the decision making phase, it
is the financial manager's responsibility to follow a certain methodology and perform a number of
calculations in order to evaluate each machine separately as an independent project. Then, each
project is evaluated and compared with the other. In the end, the financial manager demonstrates
the results and makes the recommendation.
The financial management starts the evaluation with the determination of values for the evaluation
of each machine. This is done through: (1) the development of incremental cash flows (2) initial
investment cash flows for all machines, (3) the calculation of incremental operating cash flows,
(4) the calculation of terminal cash flows and (5) the calculation of discount rate
The managers decide to apply capital budgeting techniques such as: (a) the payback period (PB),
(b) the net present value (NPV) and (c) the internal rate of return (IRR). Moreover, the parameter
of risk is incorporated in the calculations. It is important to take into consideration the uncertainty.
Risk can affect seriously the process of evaluating the investment and, then may alter final
The required data for analysis has been gathered by financial manager, which is presented as


Old Machine: The machine has a current installed cost of Yearo :$ 400,000 and a remaining economic life of 6
years (if the company decides to keep it). Its current net price is $ 400,000. We assume that if the
company would decide to purchase it, this would cost the amount of 400,000 $ in year (0). Below are given the relevant annual depreciation amounts: Year : Annual Depreciation 1 100,000
= 130,000 50,000 55,000 50,000 15000 400,000 If the old machine will be kept, it is expected that the machine could be sold at the end of year 6
for $ 40,000, according to the initial estimation. The taX rate for the company is 35 % or (0.35).


Machine A This new machine costs $ 1000,000. It has an additional installation cost of $ 100,000. Thus, the
installed cost is Yearo= $ 1100,000. This machine could be sold at the end of year 6 for Years =$
150,000. The purchase of this machine is expected to increase the net working capital of the
company by 50,000 at the yearo (Time of purchase). The machine has an installed cost of Yearo : $ 1100,000 and an estimated economic life of 6 years. Below are given the annual depreciation amounts: Year Annual Depreciation
1 200000 2 300000 3 250000 4 5 150000
150000 6 50000 1100000 The taX rate for the company is 35% (0.35).



2) Cost 0: Capital: When evaluating an investment, it is required to take into consideration (a) the time value of money
to be invested (opportunity cost) and (b) the risk taken in the investment (risk premium). The
Capital Asset Pricing Model (CAPM) is used as a formula to estimate the cost of capital which is
the key input in the capital budgeting process and the valuation of an investment, financial manager
will follow CAPM to calculate the cost of capital which is actually the required rate of return. It is
worth to mention that all percentages are given by the general manager and they are based on assumptions.
a. Rf = 4.5 % b. Rm=10%
c. B=l.5 Required:
1) Compute Total Initial Net Investment (Cash outflow at the time of purchase) 2) Calculate incremental operating cash flows
3) Calculate incremental Relevant cash flows (Machine A— Old Machine) and (Machine B-
Old Machine)
4) Calculate terminal cash flow (Cash flow at the time of sale of the machines, End of
year (5)
5) Calculate discount rate (WACC) using CAPM equation
6) Evaluate the projects using capital budgeting techniques:
a. Payback Period
b. Net Present Value (NPV)
c. Internal Rate of Return (IRR) 7) Finally, which projects would be selected based on your investigations Instructions : / Students should use Excel worksheet for calculation and put the results in the tables / The equation and the calculation process should be written.

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