NPV Tips and Template

~This template is now available for download in excel format so that you can see all the links and formulas: NPV Template ~

~This template is now available for download in excel format so that you can see all the links and formulas: NPV Template ~

This is the template that I used during the CMA Case Exam. I typed it in quickly for the first alternative and then copied and pasted it for all the other alternatives. This way, as I was approaching each alternative, I just had to fill in the data and all the calculations were already set up. This helped me streamline and speedup the (Net Present Value) NPV process and to not forget any of the NPV components. 

Below is a discussion of each of the above components as well as some general guidelines for NPV calculations:

General notes:

• Unless otherwise suggested, calculate a 5 year NPV with deemed disposition at year 5 (hence the salvage value at year 5). 
• Try not to calculate anything using the calculator. Use the securexam's mock excel so that if you need to change assumptions or fix errors all you have to do is change one number and everything gets recalculated for you.
• Remember to use incremental after tax cash flows.
• Financing costs are not relevant to NPV and should not be included (ie. the interest that will have to be paid for the line of credit that will fund the investment is not something that is relevant to the NPV calculation).
• Always state all of your assumptions clearly and show an audit trail.

Discussion of 'a' through 'f':
Note: In the above template and for the purpose of this example I assumed $40 million investment, $2 million salvage value, tax rate of 38% , a CCA rate of 15% and a discount rate of 8%.

a) This is the total of the one time/upfront investments that are required for the capital project. Remember to show this as a negative figure to ensure that the total sum of all the NPV components is correct. 

b) This is the tax shield that we get from the acquired capital. Use the correct CCA rate depending on the asset. If the investment consists of several assets, each with a different CCA rate, than you will need to calculate the tax shield for each asset separately. 

c) Here we calculate the present value of the salvage. We know that salvage value in 5 years (remember deemed disposition) is $2 million but for NPV we need to calculate the present value of this $2 million. 

d) There are two components to this part. 

• First, we calculate the tax shield that we will loose due to the deemed disposition in year 5. In 'b' we calculated the total tax shield for the investment assuming no disposition due to the nature of the CCA tax shield formula (it calculates tax shield for the life of the asset). However, since NPV assumes disposition in year 5, you have to take into account the tax shield that is being lost due to the deemed disposition of the capital. (ie. if we bought a machine that would yield a tax shield of $10 over 8 years, and then we decide to sell it in year 5, we will not get all the tax shield from it as we sold it before we had a chance to benefit from all the tax shield). 
• The tax shield lost calculated so far is a figure as at year 5 (its a Future Value for us) and therefore we now need to discount it and calculate its Present Value. The second component is where we take the FV of the tax shield lost and calculate the corresponding PV. 

e) This is the Present Value of the incremental cash flows. Remember to use the after tax figure. 

f) This is the sum of all the components that shows the NPV for the investment. Remember that an NPV of $0 is good - this means that the desired return rate has been achieved. 

~This template is now available for download in excel format so that you can see all the links and formulas: NPV Template ~

Key Elements of Convincing Strategic Recommendations

When putting together the Strategic recommendations for the May 2012 CMA Case Exam the key to remember is that it MUST be convincing. This is not an area to analyze rather an area to state, with authority and supporting backup, what the company should do and why.

Some students stumble in the recommendation section because they fail to convince the reader that their recommendations will in fact address the strategic issue. Students should not word the recommendations in a very weak and uncertain tone, in essence showing the reader that they are not sure of their recommendation. Some also forget to address any new risks that may arise due to the implementation of a strategic alternative (think cons that were listed under the strategic alternative that you are recommending). The following are elements that help create strategic recommendations that are strong, convincing and complete:

• Show that constraints are met
• Show that sufficient financing is available
• If appropriate, recommend only one alternative to avoid calculating the effect of one on the other (unless only one is not reasonable)
• Indicate how the recommended strategy takes advantage of strengths and opportunities while mitigating weaknesses and avoiding threats
• State how it will allow the company to address/resolve its overall strategic issue (ie. ‘I recommend that you buy the warehouse to expand into Canada as it will allow you to increase profits as well as market share).
• Rationalize based on pros and cons (re-worded into several overriding reasons) - Highlight the top pros for the recommended alternative as well as state how you will mitigate/address any cons associated with this alternative. For any cons that are not mitigated you should state two over-riding benefits that still keep this alternative as the right option. (ie. Even though expanding into outerwear may increase the threat from competitor A, the NPV which was calculated using conservative assumptions is positive and this alternative is in line with stakeholder preferences and capitalizes on the company’s strengths)
• Do NOT say ‘I recommend none’
• Do not be ambiguous. Use strong and convincing language.
• Cover all of the alternatives that are not recommended as well – state for each why they should not go with it. (Ie. Even though expanding into dog food is in line with the company’s strengths, this alternative has a negative NPV and is not in line with stakeholder preferences).
• Provide a brief Pro-Forma – if you do not have time for a detailed one, include very basic pro forma statements as appropriate to the situation (ie. Sales, expenses, Net Income – for 3 years, to show that your recommendations will have a positive impact on the company’s financials) – use ball park figures derived from your quantitative analysis, do not obsess about accuracy, it is better to have ball park #s than none at all
• State consistency with mission or provide a revised mission
• Propose a Balanced Scorecard

Image: KROMKRATHOG / FreeDigitalPhotos.net

Notes on Analysis of Strategic Alternatives

Aim for analyzing at least 3 strategic alternatives in-depth

 

Pros and Cons

• Pros and cons should come from information in your situational analysis (swot, constraints, stakeholder preferences, available financing, etc.) – if you can come up with a pro or con that is not related to anything in your situational analysis that often means the situational analysis is not complete and you may need to add to it.

• Word the pros and cons so that it is easy for the marker to see the integration (i.e. state that it mitigates a risk/meets a specific constraint/is not in line with a stakeholder preference, etc.)
• Consider and state the implications of one issue or alternative on another (i.e. Expanding into Canada would take up all the available financing and not allow for any other strategic alternatives.)
• Provide a quick and simple evaluation criteria matrix for each alternative and summarize it before  the overall strategic recommendations – this will help with bias issues.
• Provide a brief conclusion at the end of each alternative.

Quantitative Implications

• Not too much time or detail – ballpark if out of time. The key is to be reasonable and to show that you have incorporated and took into account the key information.
• Calculate NPV for all the strategic alternatives (if possible)
• State your assumptions - expect the case to include ambiguous and useless info. 
• NPV should be somewhere around the 0$ mark – if it is positive in the millions then it is probably wrong (review your assumptions - are they reasonable?).
• Do not recommend an alternative with a negative NPV. At the end of the day, any company, a NFP as well, needs $ to survive.
• Calculate and identify wether constraints are met and if there is sufficient financing available.
• List under Pros or Cons (if you crunched #s but did not include them in the analysis, you will not get marks for it)
• Don’t forget to link it to the right appendix (ie. ‘See Appendix A’)
• Remember to use after tax cash flows for NPV

Image: Grant Cochrane / FreeDigitalPhotos.net