Business Project Assessment

Case

Your team has just been hired by HP Inc to advice the company’s capital budgeting division about a proposed new project. HP is planning to develop a new type of smartphone, which should be able to compete with the latest Apple and Samsung models on the market. From your team of financial specialists, they are seeking advice on the financial feasibility of this project.

Over the last two years, HP has already spent $120 million on R&D to optimise the design of the new smartphone. HP’s management is uncertain whether to charge this R&D cost to the new project. If the company would decide to go ahead with the project, the development and production of the new phone will initially require an investment equal to 40% of the company’s current net property, plant and equipment (PPE), as per the fiscal year ended 31 October 2022. The project will then require an additional investment in PPE equal to 35% of the initial investment after the first year of the project. The new smartphone is expected to have a life of five years. Assume that the company will fully depreciate these assets by the straight-line method over a seven-year life. The expectation is that the property, plant and equipment can be sold at the end of the project with a liquidation value of about 10% of its acquisition values.The company will borrow $100 million to (partly) finance this project, at an interest rate of 6% per annum.

First-year revenue for the new product is expected to be 3.6% of total revenue for HP’s fiscal year ended 31 October 2022. The phone’s revenue is expected to grow at 75% for the second year, then 20% for the third, and after that decline by 5% annually for the final two years of the expected life of the product. Your team will have to determine the rest of the cash flows associated with this project. The CFO of the company has indicated that the operating

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costs of this project will be of similar proportion relative to the revenues as the company’s existing products. The new project would require an additional NWC of about 25% of the firstyear revenues of the project. Here are some additional tips to guide your analyses:

1. Obtain HP’s (ticker code: HPQ) financial statements. Download the annual income statements, balance sheet and cash flow statements for the last four fiscal years. One place to find HP’s financial statements is on investing.com, find the company and click on Financials. Make sure to get the annual financial statements, instead of the quarterly.
2. You are now ready to determine the free cash flows of the new project. Set up a timeline in a spreadsheet, which allows you to compute the free cash flows of the project on a yearly basis, in a separate column for each year of the project life. Be sure to make outflows negative and inflows positive.
   1. To estimate the annual operating costs of the project, assume, as the CFO indicated, that the project’s profitability, the ratio of Revenue / Operating costs (Operating costs may also be labeled as “Costs of Revenue”) will be similar to HP’s existing projects in 2022.
   2. Determine HP’s effective tax rate by dividing its income taxes by its income before tax in 2022.
3. Assume that the project’s cost of capital will be equal to 12%.

Report

The company is asking your team for financial advice. The results of your analyses will have to be presented as a business report to the HP executive management team. The executive management team will expect much more from the report, than just a table(s) with the NPV and IRR results. The report should have a maximum of 2,000 words, excluding appendices. And of course, since this is your team’s first assignment you will want to make a good impression. Remember, members of the executive management team often do not have a finance background.

• The report should provide clear advice on whether the company should go ahead with the project.
• The advice of your team should be (partly) based on your estimations of the NPV and the IRR of the proposed project. Remember, members of the executive management team often do not have a finance background, so your results will have to be supported by clear tables which show the calculation of the free cash flows; clear explanations of how the free cash flows were computed, what issues the capital budgeting team had to deal with, and what choices were made in these computations, and why.
• The estimated figures on the proposed project, for example the yearly revenues that the project will generate in the future, are of course just estimations – not certainties.If the company decides to go ahead with the project, these values may turn out to be different than expected. The revenues may be higher or lower than projected for

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example, or the cost of capital of the company could be higher or lower in the future than it currently is. Therefore, your team needs to perform some additional analyses.

Firstly, present a NPV profile, which illustrates the NPV of the project at various values for the cost of capital. Secondly, recompute what the NPV and the IRR of the project would be if, for example, the revenues of the project turn out to be 25% lower than projected. Your team is encouraged to provide additional ‘sensitivity’ analyses of this sort.

• A summary of recent insights in the smartphone market from reputable and credible business finance articles (including references).
• A discussion on potential risks involved with this project.
• And more… use your imagination, what does the management team need to know about this project?

Professional presentation of a visually appealing report is essential for business communication. Business reports are structured with:

• an executive summary
• table of contents
• informative headings and sub-headings
• numbered sections
• page numbering
• professionally designed and labelled graphs and tables
• a reference list.

RMIT Learning Lab provides helpful resources to assist you with referencing and writing skills and more.

Recorded Group Presentation

Your team is also required to make a recorded group presentation to present the results of your analyses to the company’s executive management team. Your team has 10 minutes (maximum) for the presentation. The presenter needs to show their face while presenting. All team members must participate in the presentation. Recording the presentation can be done using Microsoft PowerPoint (See an example on how to do it). The presentation needs to be supported using a slide deck.

The presentation should include (at a minimum!) the following information:

1. An introduction of each of the team members and their financial expertise.
2. A brief discussion of the newly proposed project. Which product/service is being developed?
3. A demonstration of the expected yearly cash flows of the project. Remember, members of the senior management team often do not have a finance background, so you will have to present clear tables which show the calculation of the free cash flows, and clearly explain how the free cash flows were computed. You basically have to explain to them in your presentation how capital budgeting works.
4. A demonstration of the NPV, the IRR, and other additional analyses of the proposed project. Again, you will need to explain to the executive team what exactly these capital budgeting metrics are, how they are computed and why they are helpful for making investment decisions. Include critical notes with each of the decision rules if you see fit.
5. Advise on whether or not the company should go ahead with the proposed project. Provide clear reasoning for your advice.