Net Present Value(NVP) and Internal Rate of Return(IRR)-Finance Writeup Sample

QUESTION

 

QUESTION 1
Caribbean Vacation Incorporated, is evaluating the purchase of a new cruise ship. The ship would cost $500 million, and would operate for 20 years. Caribbean Vacation expects annual cash flows from operating the ship to be $70 million (at the end of each year) and its
cost of capital is recorded at 12%. As planning manager in charge of new projects – you are required to address the following
key issues and to present your findings in the form of a Report to the Board of Directors.

a. Prepare a Net Present Value (NPV) profile of the purchase and estimate the Internal Rate of Return (IRR), (to the nearest 1%) from the graph.
b. Is the ship purchase attractive based on these estimates and indicate with calculations on how far off could Caribbean Vacation’s cost of capital be (to the nearest 1%) before your purchase decision would change?

 

QUESTION 2
‘The study of externalities is an important consideration in economic analysis, as it will have a significant impact on project cost analysis and appraisal. It is clear that externalities are evident in both public goods and common resources’. In the context of the above statement you are required to answer the following questions:
a. Are externalities associated with public goods generally positive or negative? Use examples in your answer. Is the free-market quantity of public goods generally greater or less than the efficient quantity?
b. Are the externalities associated with common resources generally positive or negative? Use examples in your answer. Is the free-market use of common resources generally greater or less than the efficient use?

 

 

ANSWER

 

 

PROJECT COST ANALYSIS AND APPRAISAL

Executive Summary

The report sheds light on project cost analysis and appraisal of project in context of Heathrow Terminal 5 expansion project. It highlights the internal and external environmental factors of the project. Along with that it also highlights the organisational structure of the project. Moreover, it also highlights the project stakeholder analysis and the communication of the project management. On the basis of evaluation of the environmental factors it emphasises on the success of the competition of the project. Furthermore, in order to highlight the project scope and future possibilities recommendation has been provided.

Table of Contents

TASK II

Critical Analysis of the project 

Question 1 

Project Environment 

Question 2 

Analysis of Project Stakeholder 

Management of Project communication 

Successful execution of the project 

TASK III 

Conclusion and recommendation 

Reference List 

TASK II:

Critical Analysis of the project

Question 1

a. NPV and IRR Calculation

Net Present Value helps to take major strategic decisions in terms of investment. The major purpose of NPV is to focus on profitability of the investment or the project. Therefore, this specific capital budgeting tool takes cash inflows as well as present value of money into consideration for appraising the investment mechanism (Winch and Leiringer, 2016, p.279). Therefore, in order to analyse whether it would be profitable for Caribbean Vacation to invest in purchase of new cruise ship it is needed to analyse NPV investment appraisal technique.

Formula of NPV = (Cash flows)/ (1+r)i

Where, r = discount rate = 12% (Equivalent to Cost of capital)

i= Time period = 20 years

Cash flow at end of the year = 70 million USD

Cash flow is taken as constant for 20 years. Therefore, NPV is estimated to be 5.38 million USD.

Therefore, it can be said that the company can invest in purchase of new ship as NPV after 20 years is showing positive value that means Caribbean Vacation would gain profit by investing in the new cruise ship purchase.

On the other hand, IRR would help in estimating the NPV of the project and more specifically IRR is the discount factor through which NVP of a project or an investment becomes zero.

Formula of IRR is =

Where; CFo is initiation investment

CF1, Cf2 are cash flows

Therefore, in case of Caribbean Vacation IRR will be 13% after 20 years. IRR has been calculated by taking 0.1 as guess value as it is the nearest value of 1. Along with that initial investment of 500 million has been considered as deductable amount and moreover cash flow incomes at the end of every year are considered as same over the period for 20 years.

b. Before purchasing the ship based on certain estimation and calculation the cost of capital would change based on change in discount rate. That is (13-12) %= 1% Therefore, NPV is estimated to be 63.64 USD.

Project Environment

The internal factors of the Project Environment of “Heathrow Terminal 5” requires Human Resources management, capital resources, operational efficiency, infrastructure and innovation factors that helps the project to get success by completing it within specific time period (As per the view of Laursen and Svejvig, 2016, p.742). These internal factors can be controlled by the project management department in order to get cost benefit analysis in completion of the project (Refer to Appendix).

The external environmental factors include different macro economic factors such as political, economical, social, technical, environmental and legal factors. However, these factors cannot be controlled has an immense base impact on the execution of “Heathrow Terminal 5” project.

Factors

Impact

Political

  • Stable political condition

  • Public spending

Economical

  • Lower inflation rate

  • Increasing demand

Social

  • Rising population

  • Increasing rate o0f immigration

Technological

  • Technological advancement

  • Usage of 4D and AI technology

  • Reducing the complexity of the job

Environmental

  • Provide sustainability to the environment

  • Taking environmental and green initiative

Legal

  • Implementation of Public-Private partnership law

  • Supervisory of the government regulatory body.

Table 1: PESTEL Analysis of “Heathrow Terminal 5” project

(Source: Based on the view of Todorović et al. 201, p.780)

External environmental factors have diversified impact on the project environment of “Heathrow Terminal 5” project. Heathrow Terminal 5 expansion and construction project is the public- private partnership therefore; most of the success of completion of the project depends on the political stability (Influenced by the view of Muller 2017, p.45). Therefore, stable political and governmental condition of UK as well as Britain provides efficiency to the completion of this specific project within time period. On the other hand, sufficient public spending of the government helps the project management team of “Heathrow Terminal 5” expansion project to get sufficient investment for the completion of the project. Thus, as the result 4.3 billion GBP was estimated construction cost of the project which was mostly invested by British Airport Authority (BAA).

On the other hand, economical environmental factor such as lower inflation rate in UK economy which is approximately 2.5% has increased the effectiveness of the project implementation. As it is know that lower inflation rate increase the market demand of the service along with lower price facilities. Thus, in case of constructing and expanding the Terminal 5 of Heathrow Airport the cost would be lower by 1.5 million GBP from the estimated construction and infrastructure cost. Along with that technological implementation cost is also lower due to the lower inflation rate (AIRPORT TECHNOLOGY, 2019).

The term social factor in context of expansion of Terminal 5 of Heathrow Airport emphasises on the positive effect of the project planning as the population of UK is increasing day by day. In last 25 years UK population has increased by 5% which indirectly impacts the expansion of Terminal 5 in Britain’s busiest airport Heathrow. On the other hand, Increasing Immigration rate by 2% has resulted in the successful execution of the project of expansion Terminal 5.

Technological factor plays an important role in infrastructure project set up. That means developed infrastructure requires implementation of effective technologies in order to provide efficient services to the public (As per the view of Aarseth et al. 2017, p.1075).

In case of expansion project of Terminal 5 of Heathrow Airport, in order to overcome the infrastructure challenges ‘The T5 Agreement’ was implemented by the BAA which emphasises on the integration of outsourced teams of suppliers focusing on the manufacturing as well as designing and assembling the infrastructure. The success of expansion of Terminal 5 depends upon the usage of 4D planning tool. Thus, the effectiveness of technological factor implementation this project’s results in identifying possible clashes between contractors as well as saving 2.5 million GBP in the first nine months of implementation of 4D planning tool (Rogers Strik harbor + Partners, 2019).

According to Winch and Leiringer (2016, p.270), a successful project execution always requires sustainability in terms of environment. That means no project can get success in the market without emphasising on the environmental approaches.

Expansion of Terminal 5 of Heathrow Airport project has immense effect on environment. The expansion project does not break the environment sustainability. Overall project emphasises on environment friendly outlook that means. Therefore, Air pollution control system and Air traffic control system has been implemented in order to mitigate the environmental risk that might occur due to execution of the project. On the other hand, Heathrow airport’s green initiative also broadens the path of success to the project fulfilment.

Legal factors regarding the laws and regulations of public-private partnership as well as air traffic rules and customs rule play a vital role in case of successful execution of the Heathrow Terminal 5 expansion project. The project management department starts their work based on rules and regulation statement (Influenced by the view of Aarseth et al. 2017, p.1080).

Question 2

a. As per the economic analysis, theory of externalities is used to analyse cost or benefit effect of an economic activity. A public good can be considered neither excludable nor rival. Excludable goods is defined as the good which can be prevented from using by a consumer whereas rival good can be referred to as such situation where a person’s use of one particular good reduces enjoyment of good by another person. This is because benefits that have been received by a person do not reduce or compromise with the benefits received by another person (Eskerod et al. 2015, p.12). As for example, national defence is a public good as it is neither excludable nor rival. Due to presence of social value is higher public goods has zero free market quantity making it less than efficient quantity. In case of demand and supply of public goods damages of IRR calculation is not included as the demand of the services is more therefore focus is always on the benefits of internal rate of return.

b. externalities related to common resources are negative. Common resources are not excludable and priced. For example; police force is always available whenever the crime happens until the overall force is overworked. Therefore, it can be said that police protection is rival factor as police are being busy and answering all the crimes therefore, one person’s approach to police decreases the scope of other people by making them unavailable for services. Moreover, as common resources are not priced people often overuse them. Private value of usage of common resources exceeds the social value (Todorović et al. 2015, p.778). Therefore, free market quantity of common resources is not zero. Damage tends to be more in case of common resources IRR calculation emphasis on the damages more than the benefits of the demand of common resources.

Analysis of Project Stakeholder

The term stakeholder refers to specific person who expects the outcome from a specific project. That means withoutt a stakeholder the project would not be valid. As opined by Eskerod et al. (2015, p.45), project stakeholders are the sponsor of the project and hopes to get certain outcome in terms of cost, quality and other criteria.

In case of Heathrow Terminal 5 expansion project, it is also necessary to analyse project stakeholder statement. Thus, the project stakeholder statement analysis of this project is as follows:

Identifying the stakeholders

Stakeholders

Influence of the stakeholders

Government

Works as the investing body and observe that if there is any violation of government rules and regulations.

Public

Gets the benefits from the project by availing the service provided.

Suppliers

Supplies raw material and other resources for infrastructure facilities to get return from the profit of the project

Investors

Invests in the project to get return on profit and earnings of the project.

Technological Professionals

Provides technical and technological support to the completion of the project

Auditors

Audits the overall spending as well as cost and income generated from the project and evaluates the effectiveness and efficiency of the usage of financial resources.

Environmental Auditors

Audits the environmental approach of the project, so there would be no violation of the rules related to environment protection.

Table 2: Identifying the stakeholders

(Source: Eskerod et al. 2015, p.48)

Thus, from the above table it can be understand that, infrastructure project of expanding Terminal 5 of Heathrow airport includes different stakeholders such as Government, Public, Investors, Suppliers, Technological Professionals as well as Auditors and Environmental Auditors. It can be noticed that government can be included as stakeholder due to get the clearance certificate and permission certificate from the government to start the project. On the other hand, government also invests in this project (As per the opinion of Svejvig and Andersen, 2015, p.289). Thus, due to tax payment, government can be termed as stakeholder.

On the other hand, suppliers provide resources to the execution of the project in terms of material, workforce, machinery and other inventories (Eskerod et al. 2015, p.47). Thus, they also expected return from the successful completion of the project as they are also the part of executing expansion of Terminal 5 project. Public can be termed as the stakeholder in case of constructing project of Terminal 5 in Heathrow airport because they are the main body who will avail the services after the completion of the project. Thus, in terms of availing the service public is one of the most crucial parts of stakeholder in case of Heathrow Terminal 5 expansion project. Along with that, investors are termed as stakeholder due to get personal benefits in terms of return on investment from the project. The major investing body in this project along with British Airport Authority is British Airways (AIRPORT TECHNOLOGY, 2019).

In the following prioritising of the stakeholder in this expansion of Terminal 5 project is shown based on their influence to the completion of the project.

Stakeholders

Prioritise of the stakeholders

Government

  • High Power

  • Closely managing body

Public

  • High power

  • Highly interested

Suppliers

  • Moderate power

  • Closely interested

Investors

  • High Power

  • Highly interested

Technological Professionals

  • Moderate Power

  • Closely interested

Auditors

  • Low Power

  • Less interested

Environmental Auditors

  • Moderate Power

  • Highly interested

Table 3: Stakeholder prioritisation

(Source: PMI, 2019)

Management of Project communication

According to the guidelines of PMI (2019), project management communication is the media component of the project through which data is managed and transferred through various modes. This management system connects the overall communication procedure. In case of Heathrow Terminal 5 expansion project, communication management process is shown as follows:

Figure 1: Communication management of the project

(Source: PMI, 2019)

Successful execution of the project

According to Henn et al. (2016, p.279), success rate of a project depends upon the external and internal environmental factors that affects the project. On the basis of these factors and critical evaluation of this factor the project would get cost benefit approaches. Thus, in case of Heathrow Terminal 5 expansion project it can be seen that strong internal factors in terms of human resources such as work forces, employees as well as technological factors such as implementation of 4D planning tools along with the technologically upgraded PRS system in the air traffic control system would get benefit to the project. On the other hand, major investment of BAA up to 4.3 Billion in construction along with British Airways would provide financial advantages to the competition of the project (AIRPORT TECHNOLOGY, 2019). Moreover, international outlook of the project management department which includes international airport contracting management along with implementation of retail sectors in other airports of the foreign countries has brought more efficiency to the execution of the expansion of Terminal 5 project.

TASK III

Conclusion and recommendation

From the critical analysis of Heathrow Terminal 5 expansion project it can be understood that due to storing investment policy of BAA in construction cost along with the implementation of 4D planning tool in technological upgradation of the project has made it to get the success in market. However, the project can be more efficient in terms of quality as well as customer services (Eskerod et al. 2015, p.10). The scope of betterment would include various air infrastructure facilities such as main terminal building, more satellite building, diversified air control tower along with the construction of runway at the terminal and maintenance of the terminal under BAA. If the project emphasizes on these scope then it would get more efficient in the market.

Thus based on above analysis it can be concluded that execution of this expansion project has immense impact on international infrastructure market. Therefore, the success of this project includes internal and external environmental factors of UK as well as British economy. On the basis of analysing the stakeholder statement it would easier to get to know the information regarding stakeholders of the project and by analysing their statement it would be more efficient to get to know their areas of interest.

Reference List

Aarseth, W., Ahola, T., Aaltonen, K., Økland, A. and Andersen, B., (2017). Project sustainability strategies: A systematic literature review. International Journal of Project Management35(6), pp.1071-1083.

AIRPORT TECHNOLOGY (2019) London Heathrow Airport Expansions (LHA/EGLL) Available at: https://www.airport-technology.com/projects/heathrow5/ [Accessed 27/03/2019]

Eskerod, P., Huemann, M. and Ringhofer, C., (2015). Stakeholder inclusiveness: Enriching project management with general stakeholder theory. Project Management Journal46(6), pp.42-53.

Eskerod, P., Huemann, M. and Savage, G., (2015). Project stakeholder management—Past and present. Project Management Journal46(6), pp.6-14.

Eskerod, P., Huemann, M. and Savage, G., (2015). Project stakeholder management—Past and present. Project Management Journal46(6), pp.6-14.

Harris, E., (2017). Strategic project risk appraisal and management. Abingdon:

Henn, L., Sloan, K., Charles, M.B. and Douglas, N., (2016). An appraisal framework for evaluating financing approaches for public infrastructure. Public Money & Management36(4), pp.273-280.

Laursen, M. and Svejvig, P.,(2016). Taking stock of project value creation: A structured literature review with future directions for research and practice. International Journal of Project Management34(4), pp.736-747.

Muller, R., (2017). Project governance. Abingdon: Routledge.

PMI (2019) Communications management Available at: https://www.pmi.org/learning/library/communications-management-project-function-knowledge-5722 [Accessed 28/03/2019]

Rogers Strik harbor + Partners (2019) Heathrow Terminal 5 Available at: https://www.rsh-p.com/projects/heathrow-terminal-5/ [Accessed 29/03/2019]

Routledge.

Svejvig, P. and Andersen, P., (2015). Rethinking project management: A structured literature review with a critical look at the brave new world. International Journal of Project Management33(2), pp.278-290.

Todorović, M.L., Petrović, D.Č., Mihić, M.M., Obradović, V.L. and Bushuyev, S.D., (2015). Project success analysis framework: A knowledge-based approach in project management. International Journal of Project Management33(4), pp.772-783.

Todorović, M.L., Petrović, D.Č., Mihić, M.M., Obradović, V.L. and Bushuyev, S.D., (2015). Project success analysis framework: A knowledge-based approach in project management. International Journal of Project Management33(4), pp.772-783.

Winch, G. and Leiringer, R., (2016). Owner project capabilities for infrastructure development: A review and development of the “strong owner” concept. International Journal of Project Management34(2), pp.271-281.

Winch, G. and Leiringer, R., (2016). Owner project capabilities for infrastructure development: A review and development of the “strong owner” concept. International Journal of Project Management34(2), pp.271-281.

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