Stannards Superstores
Running Head: STANNARDS SUPERSTORES
Stannards Superstores-Case
Stannards Superstores a new superstore, set up by a group of experience personnel who are now exploring growing demand for retail businesses changing and upgrading from manual systems to computerised systems. The company is faced with a dilemma of investing funds to upgrade computer facilities so that they can be more effective in controlling costs and inventory levels and ride-out the recession.
Part I
As per the calculations, we can easily say that the opportunity under consideration is not feasible for Stannards Superstores. We have analyzed the given cash flows of this project using techniques such as Net Present Value (NPV), Internal Rate of Return (IRR) and Payback Period (PBP). The reason for analyzing this project by multiple techniques is to increase the reliability and authenticity of our forecast. From the excel sheet, we can easily see that Net Present Value of Project is less than 1. We reject the project because negative NPVs will lead to losses in the short and long-run.
|
Year |
Inflow |
Outflow |
Cash Flow |
|
0 |
760000 |
-760000 |
|
|
1 |
250000 |
15000 |
235000 |
|
2 |
250000 |
15000 |
235000 |
|
3 |
175000 |
15000 |
160000 |
|
4 |
175000 |
15000 |
160000 |
|
5 |
150000 |
15000 |
135000 |
| NPV ($63,096.12) |
|||
| IRR 8% |
|||
Coming to IRR, the project has IRR less than the cost of capital. It means that the decision from NPV rule was correct and we have to reject the project. As per the IRR rule, we accept the project having IRR greater than the discount rate. In this case, the project have IRR less than the discount rate.
Th? ??yb??k ??ri?d i? d?fin?d ?? th? l?ngth ?f tim? r?quir?d t? r???v?r ?n initi?l inv??tm?nt thr?ugh ???h fl?w? g?n?r?t?d fr?m th? inv??tm?nt. Th? ??yb??k ??ri?d ?r?vid?? ??m? vi?ibility ?? t? th? l?v?l ?f ?r?fit?bility ?f th? inv??tm?nt in r?l?ti?n t? tim?. Th? ?h?rt?r th? tim? ??ri?d th? b?tt?r th? inv??tm?nt ????rtunity:
?rgum?nt? In F?v?r ?f ??yb??k
Fir?tly, it i? ???ul?r b???u?? ?f it? ?im?li?ity. R????r?h ?v?r th? y??r? h?? ?h?wn th?t UK firm? f?v?r it ?nd ??rh??? thi? i? und?r?t?nd?bl? giv?n h?w ???y it i? t? ??l?ul?t?.
????ndly, in ? bu?in??? ?nvir?nm?nt ?f r??id t??hn?l?gi??l ?h?ng?, n?w ?l?nt ?nd m??hin?ry m?y n??d t? b? r??l???d ???n?r th?n in th? ???t, ?? ? qui?k ??yb??k ?n inv??tm?nt i? ????nti?l.
Thirdly, th? inv??tm?nt ?lim?t? in th? UK in ??rti?ul?r, d?m?nd? th?t inv??t?r? ?r? r?w?rd?d with f??t r?turn?. M?ny ?r?fit?bl? ????rtuniti?? f?r l?ng-t?rm inv??tm?nt ?r? ?v?rl??k?d b???u?? th?y inv?lv? ? l?ng?r w?it f?r r?v?nu?? t? fl?w.
?rgum?nt? ?g?in?t ??yb??k
It l??k? ?bj??tivity. Wh? d??id?? th? l?ngth ?f ??tim?l ??yb??k tim?? N? ?n? d??? – it i? d??id?d by ?itting ?n? inv??tm?nt ????rtunity ?g?in?t ?n?th?r. ???h fl?w? ?r? r?g?rd?d ?? ?ith?r ?r?-??yb??k ?r ???t-??yb??k , but th? l?tt?r t?nd t? b? ign?r?d. ??yb??k t?k?? n? ????unt ?f th? ?ff??t ?n bu?in??? ?r?fit?bility. It? ??l? ??n??rn i? ???h fl?w.
??yb??k ?umm?ry
It i? ?r?b?bly b??t t? r?g?rd ??yb??k ?? ?n? ?f th? fir?t m?th?d? y?u u?? t? ?????? ??m??ting ?r?j??t?. It ??uld b? u??d ?? ?n initi?l ??r??ning t??l, but it i? in???r??ri?t? ?? ? b??i? f?r ???hi?ti??t?d inv??tm?nt d??i?i?n?.
N?t ?r???nt V?lu?
?n ???r???h u??d in ???it?l budg?ting wh?r? th? ?r???nt v?lu? ?f ???h infl?w? i? ?ubtr??t?dby th? ?r???nt v?lu? ?f ???h ?utfl?w?. N?V i? u??d t? ?n?lyz? th? ?r?fit?bility ?f ?n inv??tm?nt ?r ?r?j??t.N?V ??m??r?? th? v?lu? ?f ? d?ll?r t?d?y v?r?u? th? v?lu? ?f th?t ??m? d?ll?r in th? futur?, ?ft?r t?king infl?ti?n ?nd r?turn int? ????unt. If th? N?V ?f ? ?r?????tiv? ?r?j??t i? ???itiv?, th?n it ?h?uld b? ?????t?d. H?w?v?r, if it i? n?g?tiv?, th?n th? ?r?j??t ?r?b?bly ?h?uld b? r?j??t?d b???u?? ???h fl?w? ?r? n?g?tiv?.
In ?rd?r t? ??l?ul?t? th? n?t ?r???nt v?lu? ?f th? ?B? ??m??ny ?r?j??t, w? h?v? t? ??l?ul?t? th? di???unt?d ???h fl?w? fir?tly.
Fr?m th? ??l?ul?t?d v?lu? ?f N?V, w? ??n ??y th?t th? ?r?j??t h?? ? ???itiv? r?turn ?? N?V i? ???itiv?. Th? ?r?j??t w?uld r??ult in in?r???ing th? ?r?fit?bility ?f th? ??m??ny ????rding t? th? N?V r??ult?.
Th? N?t ?r???nt V?lu? (N?V) i? th? fir?t Di???unt?d ???h Fl?w (N?V) t??hniqu? ??v?r?d h?r?. It r?li?? ?n th? ??n???t ?f ????rtunity ???t t? ?l??? ? v?lu? ?n ???h infl?w? ?ri?ing fr?m ???it?l inv??tm?nt. R?m?mb?r th?t ????rtunity ???t i? th? ??l?ul?ti?n ?f wh?t i? ???rifi??d ?r f?r?g?n? ?? ? r??ult ?f ? ??rti?ul?r d??i?i?n. It i? ?l?? r?f?rr?d t? ?? th? ‘r??l’ ???t ?f t?king ??m? ??ti?n.
W? ??n l??k ?t th? ??n???t ?f ?r???nt v?lu? ?? b?ing th? ???h ?quiv?l?nt n?w ?f ? ?um r???iv?bl? ?t ? l?t?r d?t?. ?? h?w d??? th? ????rtunity ???t ?ff??t r?v?nu?? th?t w? ??n ?x???t t? r???iv? l?t?r? W?ll, im?gin? wh?t ? bu?in??? ??uld d? n?w with th? ???h ?um? it mu?t w?it ??m? tim? t? r???iv?.
In f??t, if y?u r???iv? ???h y?u ?r? quit? lik?ly t? ??v? it ?nd ?ut it in th? b?nk. ?? wh?t ? bu?in??? ???rifi??? by h?ving t? w?it f?r th? ???h infl?w? i? th? int?r??t l??t ?n th? ?um th?t w?uld h?v? b??n ??v?d. L??k?d ?t ?n?th?r w?y, it i? lik?ly th?t th? bu?in??? will h?v? b?rr?w?d th? ???it?l t? inv??t in th? ?r?j??t. ??, wh?t it f?r?g??? by h?ving t? w?it f?r th? r?v?nu?? ?ri?ing fr?m th? inv??tm?nt i? th? int?r??t ??id ?n th? b?rr?w?d ???it?l.
N?V i? ? t??hniqu? wh?r? ???h infl?w? ?x???t?d in futur? y??r? ?r? di???unt?d b??k t? th?ir ?r???nt v?lu?. Thi? i? ??l?ul?t?d by u?ing ? di???unt r?t? ?quiv?l?nt t? th? int?r??t th?t w?uld h?v? b??n r???iv?d ?n th? ?um?, h?d th? infl?w? b??n ??v?d, ?r th? int?r??t th?t h?? t? b? ??id by th? firm ?n fund? b?rr?w?d.
Int?rn?l R?t? ?f R?turn
IRR i? ?n ?lt?rn?tiv? m?th?d t? ?v?lu?t? ??ftw?r? inv??tm?nt?. ?imil?r t? N?V ??l?ul?ti?n?, IRR t?k?? int? ????unt th? tim? v?lu? ?f m?n?y by ??n?id?ring th? ???h fl?w? ?v?r th? lif?tim? ?f ? ?r?j??t. IRR ?n?ly??? ?im?lify ??rt ?f th? N?V ??l?ul?ti?n by f??u?ing ?nly ?n th? ???h fl?w? ?f th? ?r?j??t ?nd ??lving th? N?V ?qu?ti?n f?r th? r?t? th?t will yi?ld ?n N?V ?qu?l t? z?r?. Thi? r?t? i? ??ll?d th? Int?rn?l R?t? ?f R?turn. Th? IRR ?nd N?V ??n???t? ?r? r?l?t?d ?lth?ugh th?y ?r? n?t ?quiv?l?nt.
Th? IRR i? ??l?ul?t?d fr?m th? N?V ?qu?ti?n ?? th? ?t?rting ??int:
W? kn?w th?t wh?n ? ???itiv? N?V i? ?r?du??d by ?ur N?V ??l?ul?ti?n?, ? ?r?j??t i? w?rthwhil?. W? h?v? ?l?? ???n th?t wh?n th?r? ?r? ??m??ting ?r?j??t?, w? ?h?uld ??l??t th? ?n? th?t ?r?du??? th? high??t N?V.
But ??m?tim?? ? firm will w?nt t? kn?w h?w w?ll ? ?r?j??t will ??rf?rm und?r ? r?ng? ?f int?r??t r?t? ???n?ri??. Th? ?im with IRR i? t? ?n?w?r th? qu??ti?n: ‘Wh?t l?v?l ?f int?r??t will thi? ?r?j??t b? ?bl? t? with?t?nd?’ ?n?? w? kn?w thi?, th? ri?k ?f ?h?nging int?r??t r?t? ??nditi?n? ??n ?ff??tiv?ly b? minimi??d.
Th? IRR i? th? ?nnu?l ??r??nt?g? r?turn ??hi?v?d by ? ?r?j??t, ?t whi?h th? ?um ?f th? di???unt?d ???h infl?w? ?v?r th? lif? ?f th? ?r?j??t i? ?qu?l t? th? ?um ?f th? ???it?l inv??t?d. ?n?th?r w?y ?f l??king ?t thi? i? th?t th? IRR i? th? r?t? ?f int?r??t th?t r?du??? th? N?V t? z?r?.
M?king th? inv??tm?nt d??i?i?n
L?t’? ??t ?ut th? ?rit?ri? f?r ?????ting ?r r?j??ting inv??tm?nt ????rtuniti??, u?ing th? N?V ?nd IRR. Im?gin? ? ???n?ri? wh?r? th? m?n?g?r? ?f ? firm ?r? ??n?id?ring wh?th?r t? ?????t ?r r?j??t ?n inv??tm?nt ?r?j??t, ?n th? b??i? ?f th?ir ??quiring th? fund? n??????ry ?t ? kn?wn r?t? ?f int?r??t.
* Th? N?V ???r???h ??k? if th? ?r???nt v?lu? ?f ???h infl?w? l??? th? initi?l inv??tm?nt i? ???itiv?, ?t th? ?urr?nt b?rr?wing r?t?.
* Th? IRR ???r???h ??k? if th? IRR ?n th? ?r?j??t i? gr??t?r th?n th? b?rr?wing r?t?.
Th? f??t?r t? b? ??n?id?r?d in ??tim?ting ?r?j??t ?r?fit?bility i? th? ???um?ti?n? m?d? by th? ?v?lu?t?r? ?f ?r?j??t? f?r Stannards Superstores. Wh?t?v?r th? ????ifi? f?rmul? ?h???n, ?ny N?V m?d?l r?quir?? th?t th? ???t ?f ?quity b? ??tim?t?d. T?xtb??k? inv?ri?bly r???mm?nd th? ???it?l ????t ?ri?ing M?d?l (???M) t? th?t ?ff??t. Th? m?d?l ???um?? ??rf??t ?nd ???tl??? fin?n?i?l m?rk?t? ?nd ?ith?r n?rm?l ?r?b?bility di?tributi?n? ?r inv??t?r?’ indiff?r?n?? t? ??ymm?try. Th? k?y ?t?? in ?bt?ining th? ???t ?f ?quity i? t? run ? r?gr???i?n ?f ? giv?n ?t??k’ ???t r?turn? ?n ? m?rk?t-??rtf?li? ?r?xy’? ???t r?turn?. Th? r?gr???i?n ???ffi?i?nt, ?r b ???ffi?i?nt, r??r???nt? th? ?t??k’? ?y?t?m?ti? ri?k ?nd i? u??d t? d?t?rmin? th? ??m??ny’? ?urr?nt ???t ?f ?quity giv?n th? m?rk?t ??rtf?li?? ?x???t?d ?x???? r?turn ?nd th? ri?kl??? r?t? ?f r?turn. Th? ?m?iri??l v?lidity ?f th? ???M h?? l?ng b??n th? ?ubj??t ?f r????r?h. It i? n?t th? ?ur???? ?f thi? ????r t? r?vi?w in d?t?il th? ?vid?n?? ?ubli?h?d ?r ?v?n giv? ? li?t ?f ?ll ??ntributi?n?. ?u?h li?t? ??n b? f?und in m??t t?xtb??k? ?r ????i?li??d m?n?gr??h?. W? will b? ??nt?nt t? ?t?t? th?t th? ?vid?n?? i? n?t f?v?ur?bl? ?nd th?t m?ny “?ri?ing ?n?m?li??” h?v? b??n f?und. In ? nut?h?ll, wh?r??? ?y?t?m?ti? ri?k (b) ?h?uld b? th? ??l? d?t?rmin?nt ?f ? ?t??k’? ?v?r?g? r?turn ?b?v? th? ri?kl??? r?t?, ?vid?n?? ?ugg??t? th?t ?iz? ?nd ?th?r f??t?r? (?u?h ?? th? b??k-t?-m?rk?t v?lu? r?ti?) ?r? ?l?? ?ignifi??nt.
R???ntly, ?n? ?f th? fi?r???t ??rly ?r???n?nt? ?f th? ???M, F?m? him??lf, w?nt ?? f?r ?? t? ?rgu? th?t ?ur ?rit?ri?n ?nd v?rdi?t ?h?uld b? r?v?r??d: m?rk?t ?ri?ing i? n?t “?n?m?l?u?”, but th? ???M i? f?ulty ?nd “W?nt?d, D??d ?r ?liv?”. H?w?v?r, th? ?rgum?nt th?t B?t? ??rti?lly ?x?l?in? r?turn? i? n?t ? vindi??ti?n ?f th? ???M, in whi?h B?t? i? th? ??l? d?t?rmin?nt. B???u?? th? ???M i? ?u?h ? ?im?l? ?nd ?ttr??tiv? t??l, w? think th?t m?ny ?f ?ur ??ll??gu?? w?nt t? b? ??nfu??d ?n thi? ??int. ?lth?ugh th??? ?rgum?nt? ?g?in?t th? ???M ?nd “th? w?y it i? ?urr?ntly ???li?d, f?r ?x?m?l?, t? ??tim?t? th? ???t ?f ???it?l” ?r? ?m?iri??lly gr?und?d, it i? w?rth m?nti?ning th?t ??m? ?uth?r? ?h?w?d it? th??r?ti??l w??kn????? ? l?ng tim? ?g?. F?r ?x?m?l?, wh?n th? numb?r ?f diff?r?nt ???uriti?? inv??t?r? ??n h?ld i? limit?d, ?y?t?m?ti? ri?k ??nn?t b? th? ?nly ri?k ??id f?r by th? m?rk?t. Th? ?quilibrium ?ri?ing ?qu?ti?n i? mu?h m?r? ??m?l?x ?nd l??v?? r??m t? un?y?t?m?ti? ri?k.
In m?ny r??l w?rld ?itu?ti?n?, th? m??t ???hi?ti??t?d m?n?g?r? t?nd t? ?r????d in tw? ?r thr?? ?t???. Fir?t th?y ??tim?t? th? ?quity ri?k ?r?mium f?r th? “?v?r?g? m?rk?t ri?k” ?n th? b??i? ?f th? hi?t?ri??l ?v?r?g? m?rk?t ri?k ?r?mium. F?r N?rth ?m?ri??, hi?t?ri??l m?rk?t r?turn? d?ting b??k t? 1925 ?r? ??m?il?d ?v?ry y??r by Ibb?t??n ?????i?t??. ?x ???t ri?k ?r?mi? ?b?v? th? ri?kl??? r?t? ?r? ?l?? ??m?ut?d; th?ir hi?t?ri??l ?v?r?g? i? d??m?d r??r???nt?tiv? ?f th? ?v?r?g? ?x ?nt? ri?k ?r?mium ?n th? m?rk?t ??rtf?li?. Th? ?um ?f th? ?urr?nt ri?kl??? r?t? (u?u?lly th? r?t? ?n ? g?v?rnm?nt b?nd ?f th? ???r??ri?t? m?turity) ?nd ?f thi? ?v?r?g? ri?k ?r?mium r??r???nt? th? ???t ?f ?quity f?r ?n ?v?r?g? ??r??r?ti?n. In th? ????nd ?t??, m?n?g?r? mu?t ?dju?t thi? ???t ?f ?quity u?w?rd? ?r d?wnw?rd?, t? r?fl??t th? high?r ?r ?m?ll?r ri?k ?f th?ir firm. Th? ?dju?tm?nt i? ??rf?rm?d ?ith?r ?n th? b??i? ?f th? ??m??ny’? B?t?, ?f ??m? ?th?r r?l?v?nt ?t?ti?ti?? (f?r ?x?m?l?, n?t m?rgin v?l?tility, r?turn ?n ????t? v?l?tility, ?t?.), ?f intuiti?n, ?r ?f ? ??mbin?ti?n ?f ?ll th???. In ??m? ?????, th? ??m??ny’? ???t ?f ?quity i? in turn ?dju?t?d, m?r? ?r l??? ?rbitr?rily, t? r?fl??t th? high?r/l?w?r ri?k ?f th? ?r?j??t und?r ?tudy. ???d?mi?? ?r? u?u?lly un??mf?rt?bl? with thi? mixtur? ?f intuiti?n ?nd ???t ?b??rv?ti?n?. N?t ?? ?r??titi?n?r?, wh? ?r?f?r t? r?ly ?n th?ir ?x??ri?n?? r?th?r th?n w?it f?r th? ?v?r ?lu?iv?, ??rf??t f?rmul?. ?t l??t, if ?r?j??t? ?r? t? b? v?lu?d ???uming 100% ?quity fin?n?ing, ?r ? ??r??nt?g? diff?r?nt fr?m th? ?urr?nt ??m??ny-wid? r?ti?, th? ??m??ny’? ?urr?nt ???t ?f ?quity mu?t b? un-l?v?r?d ?nd, if n??????ry, r?-l?v?r?d. Until m?r? i? kn?wn ?b?ut th? n?tur? ?f ?n ??tim?l ???it?l ?tru?tur?, w? ?ugg??t th?t g??d ?t?rting ??int t? un-l?v?r ?nd r?-l?v?r th? ???t ?f ?quity ??n b? ?r?vid?d by N?V f?rmul?: thi? f?rmul? ?h?w? h?w th? ???t ?f ?quity v?ri?? with d?bt with?ut ???uming ?ny ???t ?r ?dv?nt?g? t? ?ny ??rti?ul?r ??ur?? ?f fin?n?ing.
References
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Salvato, Carlo; Predictors of Entrepreuneurship in Family Firms; 2004, Journal of Private Equity, Volume 7, Number 3, pp. 68-76
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