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Finance Essay for a Senior Manager

Imagine that you are a senior manager of a company operating in Hong Kong in a highly innovative and competitive market with an annual turnover of US $500,000,000 and that you have a first draft of what can be a good business opportunity with an estimated investment (sunk) cost of US $50,000,000.

Your intuition is that it might be sensible to go ahead with the investment, but, given its size and the high risks involved in such a decision, the company should study very carefully the investment project. In order to do so you decided to organize a task force with the company's best economists, accountants and engineers.
You formally invited each member of the task force members for a first meeting, taking place next week, where you intend to discuss the specificity of the investment report, namely, the investment appraisal techniques and risk analysis to be used, the level of risk the company is able to take, as well as to give them your view about other issues related to the investment project which you consider important to be addressed in the investment report.

a) For the circumstances above, write what you believe could be a sensible memo to send to each member of the task force to invite them for the first meeting. In this memo you should briefly summarize the investment project, stressing its potential importance for the future of your organization and contextualizing the project in the company's current core business and expected industry developments.

b) Imagine that after 8 weeks of hard work, the task force gave you a 80 pages investment report where you can see that the project has a 5 years payback period and a positive US$15,000 NPV. After reading the investment report you feel, however, reluctant to invest. Describe possible reasons which could justify your reluctance to go ahead with the investment project, despite its positive NPV.

c) Discuss the potential weaknesses of the Internal Rate of Return (IRR), Net Present Value (NPV) and Payback Period (PP) techniques to assess investments for contexts with high market, technical and technological uncertainty, and the advantage of using the Real Options methodology in such cases. Your discussion regarding the advantage of the real options methodology must be supported by a brief introduction of the main aspects underlying the Real Option Theory and the use of relevant real options literature (3-6 relevant articles at least).

Solution Preview

Please refer to the attached file for the response.

PROJECT PROPOSAL AND EVALUATION

Point of view: Senior Manager
Place of operation: Hong Kong, a highly innovative and competitive market
Expected Cash Flow: US $500,000,000 year
Initial Investment: US $50,000,000
Task Force to Analyze the Project: Economists, accountants and engineers.

CORE PROBLEMS:
1. Memo for each member of the task force summarizing the investment project, its potential importance for the future of the organization and contextualizing the project in the company's current core business and expected industry developments.

MEMORANDUM
FOR: Project Analysis Task Force Members
FROM: Senior Manager
DATE: N0vembver 30, 2011
SUBJECT: Investment Proposal Concerns

XYZ Corporation is considering a project that aims to achieve the firm's targets for growth and development. With an expected annual future cash flow of US$500,000,000 and at an initial investment (sunk cost) of US$50,000,000, the project would have a significant effect on the capability of the organization to increase its profitability and ability to maximize the value of shareholders' wealth.

The proposed project would be in the form expansion of market territories for the company's high-end furniture into at least three Asian countries, hence the need to study the feasibility of putting up marketing and possibly production operations in at least three Asian countries that would be selected. Potential countries include Singapore, Thailand, and the Philippines. The said project would provide the company an opportunity to increase its marketing position, profitability, and the chance to meet the expectations of shareholders, employees, and other stakeholders.
The products would target high-income groups of consumers as well as industrial and government buyers. This would mean an expansion of the company's existing market segments that is composed of local buyers who belong to average income groups and government buyers. This would necessitate expansion of production capacities.
Expanding into the said territories will require an extensive study of the countries' culture, legal and political requirements, economic condition, business practices, potential competitors, infrastructures, as well as natural, demographic, and other physical factors. These aspects would affect the degree of risk that the company must have to handle and manage in order to convert possible threats into opportunities. Hence, a voluminous task ahead.
Please be ready with adequate and reliable inputs that would be used in order to come up with the following specific decisions on the following areas:
1. Finance. Capital investment requirement, source of funds, and the corresponding financial commitments. This would also include decisions on:
a) Investment appraisal techniques. Possible valuation techniques are: Payback period, Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI), Modified payback period, and Modified Internal Rate of return method. The proposed project will be evaluated on the basis of selected appraisal technique that would be decided by all members of the task force.
b) Risk analysis. Because of the uncertainties, the task managers must be definite as to what they must perceive as risk and how this would be integrated in the decision making. According to Keown (2002), risk must be considered in financial decision making.
Risk may be defined as deviation from expected outcome or degree of variability of the estimated outcomes of the project. According to Keown, it could also mean the prospect of unfavorable outcome. Various forms of risk must be analyzed in terms of their relevance and implications to the financial feasibility of the project at hand. In relation to the project at hand, relevant forms of risk may include: 1) ...

Solution Summary

This solution provides a detailed discussion of the given finance questions.

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