Corporate Finance
Semester Project
BLAER Investment Decision
Introduction


BLAER ltd. is a construction company. It constructs
large industrial buildings and also provides
maintenance services. It has almost 150 employees and
has an annual sales of around £35 Million.
The company has been using a crane that is 10 years old
and has 5 years remaining useful life. But it is getting
unreliable with time. A proposal has been put forth to
buy a new advanced crane.
The Decision

Now the management has to decide whether they
should continue using the old crane till its end of useful
life or they should switch to the new crane now.
Data
Old crane
New crane
Purchase price
£195,000
£345,000
Scrap value
£5,000
£30,000
Current Market value
£20,000
Book value after WDA
£10,981
Useful life
5 Years remaining
Maintenance cost
£40,000
Running cost
£40,000
10 Years
£60,000
Running the old crane
The cost of break down = £ 15,000 productivity loss + £10,000 fixing cost
= £ 25,000
50% chance of breakdown = 50% × 25000 = £ 12500
Incremental revenue
60% chance of getting two contracts = 60% * (40000 × 2 ) = 48000
20% chance of getting four contracts = 20% * (40000 × 4 ) = 32000
Total revenue every year = 48000 + 32000 = 80000
Annual Running costs
Depreciation
(Using the straight-line method of depreciation)

Depreciation of old crane =
195000−5000
15
Depreciation of old crane = 12667 per annum

Depreciation of new crane =
345000−30000
10
Depreciation of new crane = 31500 per annum
Depreciation
Terminal CF at end of 10 years
Initial Investment
Net Present Value
Internal rate of return
IRR
14%
Payback Period
Accounting rate of return
Merits and demerits of new crane
Merits
Demerits
i.
i. A higher running cost
ii. A much higher price than the old
crane
New crane is technological more
advanced.
ii. Suits the firm’s image as
innovative and advanced
construction firm.
iii. Will help reduce costs and win
new contracts
1. Financial analysis required by BLAER CE
The capital expenditure is presented in any of the 3
categories:
1.
2.
3.
Essential replacement of existing asset (Category
1)
Strategic expansion (Category 2)
Safety and regulations (Category 3)
The Bush Lift purchase falls under the category 1, as it will replace an old crane that is getting unreliable with time. Net Present Value (NPV) and Payback Period of the Capital Expenditure project were calculated. If the project gave a positive NPV an d its Payback period was less than 5 Years, then the projects were approved.
1. Financial analysis required by BLAER CE
The Bush Lift purchase falls under the category 1, as it will
replace an old crane that is getting unreliable with time.


Net Present Value (NPV) and Payback Period of the
Capital Expenditure project were calculated.
If the project gave a positive NPV and its Payback period
was less than 5 Years, then the projects were approved.
2. Real Vs. Nominal Rate
Real Interest rate
Nominal interest rate
• The real interest rate has the element • Nominal interest rate refers to the
of inflation adjusted in it.
interest rate before taking into
• It is calculated by subtracting the
account the inflation factor.
inflation rate from the nominal
• It is calculated by adding the
interest rate
inflation rate and the real interest
• Investors tend to use real discount
rate.
rate to also consider the risk of
• They are generally advertised by
inflation.
banks, debt issuers for loans and
various investments.
Why 21% maybe too risky

The firms tend to keep this figure within
single digits. The 21% rate is very high return
rate fro judging the return of any investment.
It is also stated that 21% is the nominal interest
rate that does not have effect of inflation
adjusted to it.
3. The revised NPV

The revised NPV of BL crane investment is
around (60,151). Although the NPV suggests
that BL crane should not be purchased but we
can’t just rely on the verdict of a single
number.
4. IRR

Internal rate of return is used to calculate the
exact rate of return of an investment taking
into account the time value of money as well.
It gives better understanding of the cash flows
of the project. Company should use IRR to
calculate the overall profitability of the
projects.
5. Risk and uncertainty
Analyzing risk and uncertainty is one of the key factors for
making successful investments. Company can use the
following methods to analyze and visualize the risk and
uncertainty of the project:
 Decision-tree method
 SWOT analysis
 SWIFT analysis
Key variables in BL investment
The main variable in BL investment are:
 The advance technology used in the BL crane.
 The new contracts that it will attract.
 The BL crane suits the innovative image of firm.
 The unreliability and break down of old crane.
Any further useful information

The company should include calculating IRR
in its capital expenditure manual. SWOT
analysis in its proposal too rather than relying
on just material facts and figures. Because the
successful
Conclusion


The company should go for the new crane.
We cannot just rely on NPV and figures for
some decisions. The old crane is making
company miss out contracts and