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Capital Budgeting Analysis of Tanzi-power （case1） ID:064175240 Name:徐孟英ContentsPart 1: Introduction to the case background.2Part2: Problem definition and Assumption.2Part 3: Case-study analysis.2.Fundamental analysis3.Sensitivity analysis3 （）Based on the analysis of inflation.3 （）Based on the analysis of discount rate.4 （）Based on the analysis of the sources of initial investment.4 （）Based on the analysis of fixed assets.5Part 4: Summary 6Part1： Introduction to the case backgroundTanzi pump is a major selling water pumps. The major users of oil processing and chemical. In 1986, Tanzi has made a major technological breakthrough and developed a large number of powerful, computer-controlled switching the oil refining pumps. But comparing the Tanzi power , Tanzi power of 220 000 U.S. dollars more to buy, and demanded from many customers. Part2： Problem definition and AssumptionIn this case, the most important problem need to be solved is that if it is reasonable and effective to replace the pump line and choose from TanZi-power to TanZI-power .The challenge facing Tanzi and its sales management was that virtually all of their existing pumps were priced under $40,000 and were purchased by plant manager customers without the nuisance of a full “capital expenditure analysis”. With a $260,000 purchase, however, most customers need prepare a full “capital expenditure analysis” which was then sent to headquarters for approval. So now we have to make a comprehensive and thoughtful analysis of the capital expenditure report to tell headquarters whether it is worth to buy the new pump instead of the old one.To make the problem can be describe analysis and solve by the way of quantification, we make the follow assumption before we committee to analysis the question:First: Without inflation. The price of the new pump is $260000, and the old one is $40000. With the inflation, total labor and electricity saving the first year were estimated to be $60000 and expected to increase at a 5 percent compound rare per year. On the contrary, without the inflation, the saving would be fixed at $60000 per year.Second: Depreciation methods, tax rate and rate of return. The new pump had an economic life of 8 years, however, we used 5-year depreciation class method to facilitate the calculation. Any expected salvage value at the end is ignored when figuring the cost basis for depreciation. In fact, at the end of its useful life, year 8, it is expected to have a salvage value of $30000. As a result, the estimated salvage value will be taxed at the ordinary income tax rate of 38 percent. In addition, the required rate of return is 13 percent after taxes.In addition, two machine depreciation methods remain unchanged, but the old with no residual value in an inflationary.Part3： Case-study analysisCompounding the present value coefficient tableyear10%11%12%13%14%15%16%17%18%19%20%21%10.90910.90090.89290.88500.87720.86960.86210.85470.84750.84030.83330.826420.82640.81160.79720.78310.76950.75610.74320.73050.71820.70620.69440.683030.75130.73120.71180.69310.67500.65750.64070.62440.60860.59340.57870.564540.68300.65870.63550.61330.59210.57180.55230.53370.51580.49870.48230.466550.62090.59350.56740.54280.51940.49720.47610.45610.43710.41900.40190.385560.56450.53460.50660.48030.45560.43230.41040.38980.37040.35210.33490.318670.51320.48170.45230.42510.39960.37590.35380.33320.31390.29590.27910.263380.46650.43390.40390.37620.35060.32690.30500.28480.26600.24870.23260.2176I. Fundamental analysis (NPV,PP,ROI.IRR,PVI)Tax=38% Rate of ruturn=13%yearSRCS(cash)DepPbtPatNCF0220000160000440001600099205392026300070400-7400-4588658123661504224023910148245706446945825344441142735052694572930253444758629504548486765771267263905396215229378040608040649852498528844260844265234452344Year 13%pv10.885047719.220.783151537.3830.693139551.0640.613332317.2350.542829771.4960.480325116.3370.425121192.0980.376219691.81NCF=(CS-DEP)*(1-38%)+DEPNPV=pv-Inv=46896.59NPV0 FeasiblePVI=1.211 FeasibleIRR=19.17%13%IRRrate of returnFeasibleyearAnnualNCFTotalNCFNot-recovered investment1539205392016608026581211973210026835706417679643204452694229490-9490ROI=9920-4588+14824+27350+29504+39621+49852+52344)/8/220000*100%=12.4334%PP=3+43204/(229490-176796)=3.823.828*50% FeasibleII. Sensitivity analysis(I) Based on the analysis of inflationi. All the conclusions are based on the information that has told us. Then, with inflation, the customers savings are increase at a 5 percent compound rare per year.In this case, the cost savings change as follows:Year12345678Cost save6000063000661506945872930765778040684426NCF5392065812570645269454848522934985270944PP=3.82 IRR=19.85% NPV= 53887 ROI=12.43%Assume the economic environment is better in year 2 and beyond, and all the customers dont adjust upward for inflation-expected savings in year 2 and beyond. The other assumptions are changeless. In this case, every years cost savings are constant as follows:Year12345678Cost save6000060000600006000060000600006000060000NCF5392063952532514683146831420153720055800PP= 4.04 IRR=16.55% NPV=25829 ROI=9.16%ii. Assume the inflation is aggravated in year 2 and beyond, and all the customers adjust upward at 8% compound rare for inflation-expected savings in year 2 and beyond. The other assumptions are constant.In this case, the cost savings change as follows:Year12345678Cost save60000648006998475583816298816095212102830NCF5392066928699175649260241594755903182355PP=3.70 IRR=21.87% NPV=73308 ROI=14.73%Comparison of different after-tax NCF, we can see that . is the highest, while . is the lowest. The changes influenced by inflation are obvious. The more the inflation-expected savings increasing, the better to invest the Tanzi pump .(II) Probability analysisThe economic grows in 1982-1986 years and the inflation has downward trend. So, we make estimations of the inflation as follows：Various Inflations In The FutureInflationThe rate of savings increaseProbabilityIRRChangeless5%0.719.85%Weaker0%0.216.55%Aggravated8%0.121.87%A=5%*0.7+0%*0.2+8%*0.1= 4.3%B=19.85%*0.7+16.55%*0.2+21.87%*0.1= 19.39%We can get the expected value of IRR (with B representation ),and another index with A representation. So, we can see when the rate of saving increase keep in 4.3%,the expected value of IRR could be 19.39%. In addition, the customers required rate of return is 13% which shows in basic information. It is obvious that 19.39% much larger than 13%, which means the Tanzi pump corporation already leave some profits to customers.The discount rate analysis (III) The discount rate analysisAt the beginning of analysis, we must note that the discount rate goes on to say only means the expected rate of return, the other two cost of capital and opportunity cost are not in our consideration.In the basic program, we assume that the required rate of return is 13%. The factors that impact the required rate of return include no risk premium, the projects coefficient and the average market return. If the projects coefficient and the average market return are not changed, the required rate of return will increase with the growth of the no risk premium. The reverse is also true. If no risk premium and the projects coefficient are changeless, the required rate of return will also increase with the growth of the average market return. We can assume the no risk premium be equal to the Short-term interest rate of treasury bonds. At that time, the average Short-term interest rates of treasury bonds is 9%. Obviously, the required rate of return has to be higher than the above-mentioned. So in the following cases, we will give five different required rate of return. They are 10%, 13%, 16%,19% and 21%.The rate of return i=10%/16%/19%/21%, tax=38% Year(Inr)0 1 2 3 4 5 6 7 8 I Inv(220000)CS60000 63000 66150 69458 72930 76577 80406 84426 Drp.44000 70400 42240 25344 25344 12672 0 0 PBT16000 (7400)23910 44114 47586 63905 80406 84426 Tax6080 (2812)9086 16763 18083 24284 30554 32082 PAT9920 (4588)14824 27350 29504 39621 49852 52344 SV30000 CFAT(220000)53920 65812 57064 52694 54848 52293 49852 70944 PV (10%)(220000)49018 54390 42873 35991 34056 29518 25582 33096 PV(16%)(220000)46483 48909 36559 29103 26114 21463 17639 21640 PV(19%)(220000)45311 46474 33863 26277 22984 18415 14752 17642 PV(21%)(220000)44562 44950 32211 24582 21146 16662 13127 15440 NPV(10%)=84524 NPV(16%)=27909 NPV(19%) = 5717 NPV(21%) =-7319 We can see that NPV decreases as the discount rate increases. Even if the NPV deduction of more, the incremental of the discount rate is still keep the same. When the discount rate gets 19.85%, the NPV just be equal to 0. Actually the discount rate changes in real life, it is absolutely impossible remain the same during 8 years. The possibility of the discount rate higher than 19.85% is very small. Nevertheless, oil is a kind of very important resource, always under the macro-control and it plays a pivotal role in a strategic position. The government will not allow the price raise freely. It means that the required rate of return will not be changed a lot.(IV) Fixed-assets investment analysisFrom the calculation above, we know that the actual rate of return was greater than the 13%.We can get a form as follows: Year (Irc) 0 1 2 3 4 5 6 7 8 I Inv(294242) CS60000 63000 66150 69458 72930 76577 80406 84426 Dep.58848 94157 56494 33897 33897 16948 PBT1152 (31157)9656 35561 39034 59629 80406 84426 Tax438 (11840)3669 13513 14833 22659 30554 32082