Project evaluation is a paramount part of financial management that ensures every project approved and undertaken by an entity has a high probability of been profitable (Finnerty, 2013). In this regard, the initial task of making an investment decision involves appraising the proposed project to establish its viability. By definition, a project appraisal refers to a comprehensive and systematic review of social, economic, financial, environmental, technical and all other aspects of the project that determines whether it will meet the set objectives. The central objective of the LAD TelEQ Plc, as it is for many organizations, is to improve its profitability, increase its line of products and services and in overall maximize the wealth of the shareholders. Given that the company focusses mainly on developing wires solutions for communications and providing systems and components for the communication, every project undertaken by the company must revolve around this area, given that the company has much experience in the area unless it wishes to diversify its product portfolio in other sectors.
The aim of this report is to present an analysis of the proposed Wireless Smart Home Devices development project, duped ‘CarHome Project.’ The analysis of the project can be carried out using various methods, but the discounted cash flow method is preferred for this analysis given its wide acceptance and applicability and its consideration of the time value of money. In essence, the report appraisals the project using the net present value (NPV), internal rate of return (IRR), payback period, and sensitive analysis techniques. On addition to this, the report evaluates the technological business environment, specifically the wireless communication external business environment in light of the level of competition, legal structure and other opportunities and barriers that would affect the viability of the project. The report commences by calculating the cost of capital, the presents analysis of the project using NPV, IRR, Payback period, sensitive analysis, business environment and concludes by giving the recommendations to the company’s management on the proper course of action given the analysis results.
CarHome Project Appraisal
The ensuing segments present critical and analytical appraisal of the CarHome Project with a view to issuing sound and informed recommendations to the LAD TelEQ Plc management.
- Weighted Average Cost of Capital (WACC) for LAD TelEQ Plc
WACC refers to the rate which an entity expects to pay on average to all of its security holders in order to finance its assets (Pástor, Sinha, and Swaminathan, 2008). The assets of LAD TelEQ Plc are financed by both equity and debt, and WACC of the company is the average of the costs of the two sources of financing. Each of the sources of finance will be weighted by its respective use in the company. In general, WACC is obtained by (Truong, Partington and Peat, 2008):
||E / (E + D)
||Cost of Equity
||D / (E + D)
||Cost of Debt
||(1 – Tax Rate)
Based on this formula the WACC for the LAD TelEQ Plc will be:
The market value of equity (E) (Market capitalization) of TelEQ Plc is £938 million
Given as (350/ 100 * 268, 000 000)
The market value of debt is £2 million (issued in bonds).
Weight of equity = E / (E + D) = £938/ (938+ 2) = 0.998
Weight of debt = D / (E + D) = 2/ (938+ 2) = 0.002
Cost of Equity
Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market – Risk-Free Rate of Return)
Considering the 10-Year Treasury Constant Maturity Rate as the risk free rate the current risk free rate is 1.78% (Guru Focus 2016)
Assuming that the beta for the LAD TelEQ Plc is 1.2 (using the technological average market beta in UK)
The appraisal of the project will required the market premium (Expected Return of the Market – Risk-Free Rate of Return) to be 7.5%.
Cost of Equity = 1.78% + (1.2……………….