Hgm Project Valuations

HGM investment into a new chemical manufacturing project can create shareholder value, if all assumptions hold true. Initial cost and revenues and cost estimates remain true as shown in part A. it will net a positive NPV of $419,435 and IRR of 18%. We can conclude the investment is viewed favorably, HMG should undertake the project. Under part B conditions if the variable cost estimates where 55% rather than 45%, the NPV would be – 599,080.This would indicate that the investment would be unprofitable only yielding a IRR (10%) which is much lower than the WACC (15%) and HGM therefore should not accept the project.

Our approach to HGM project valuation would have to start with what information is not available. Given that HGM is a manufacturing company keeping variable cost low should be at the forefront but we can only estimate what contributes to their V.C. The outlook to the economy, could affect HGM estimates of sales volume estimates. If HGM revaluates its valuation if must utilize a scenario analysis or break-even analysis. The scenario would allow HGM to see what happens if market or economic outlook where moderate, pessimistic or optimistic. The break-even analysis using goal seek within excel can compute what percentage variable cost can rise that would produce a zero NPV or make IRR equal to the discount rate. The break-even variable cost that HGM can have is 49% only 4% more than there original estimate.

We believe that because the company cannot accurately gauge the actual variable cost they should consider some flexibility to their initial investment of $4 million. Utilizing the goal seek on the initial investment break-even amount of $4,587,106. This is a 14% difference and in comparison to the amount variable cost can rise until it hits its break-even point it has more room. The project also has a salvage value of 10% of the equipment and plant. We believe that the salvage value should be zero and have very little impact in the forecast unless the project has value for a follow project.

Our conclusion of the project overall is that it is exposed to a lot variable cost risk and a manufacturing company needs to have more flexibility or information of control in their variable cost. If you consider the economics of today, factors in the economy such as the price of oil can have a ripple effect on many industries overall.

The Investment of HMG will create shareholder value given that the project will produce a positive NPV at $419,435 and IRR of 18% which is greater than the 15% from the required rate of return. The decision for HMG will be to undertake the project but is based solely off the projection in part A. Although if you consider alternative scenario such as part B of the problem 2-9, If the estimated variable cost of were to rise to 55% the projects NPV would be negative and IRR less than 15%.

If more information where available about the outlook