Tuesday, June 21, 2011

Double Discounting method: Case Analysis of Euroland Foods S.A. plus a new implement strategy (CON)

I received the emails which presented the concern about Sensitivity analysis and Double discounting methods.

Let me explain you the details each one of this methods as follows:

1) Sensitivity Analysis Method

The common question was: “Why did I choose IRR = 17% for all of projects?
First step, I chose the range of IRR more than WACC = 10.6%. For instance, IRR = 11% to IRR = 14%. Then I ranked all of projects by high NPV and high Equivalent Annuity.
Second step, I increased the range of IRR to 16%. Then I ranked again all of projects.
Third step, I continued to increase of the range IRR and control the rank of all projects in which I obtained the constant ranking for all projects, in this case was IRR = 17%

2) Double Discounting method

In this method, we should compare all projects in minimum time period of cash flows.
The index time period is 3 years that is referred to the project of Inventory-Control System. At the first, we should exchange and discount all cash flows of the projects on three years. Then we will able to calculate NPV and IRR for all projects in the same period (three years).
How can we exchange and discount all cash flows to three years?
There are two ways as follows:
-To subtract present value of total time period from present value for three years
Delta (PV) = PV (t=n) – PV (t=3)
PV (t=n) = SUM [Ct / (1+WACC) ^n]   where: t = 0 to t = n
PV (t=n) = SUM [Ct / (1+WACC) ^n]   where: t = 0 to t = 3
After that, we should replace C3 of each project by Delta (PV) + C3
-In this way, we should calculate present value in which it will be the time equal to zero (t =0) for cash flow of third year. Then all cash flows before third year accompanied by third year will be considered equal to zero. Please see the example of project (1):
Year            0     1          2          3       4       5        6        7
Cash flow    -   -11.85   4.5      5.25     6      6.75    7.5     10.5

The present value should be calculated for below state:
Year           0    1     2       3      4      5         6        7
Cash flow   -    0     0       0      6      6.75    7.5      10.5
After that, we should replace C3 of each project by (New present value) + C3
If you calculate the present value by two ways, the result will be the same.
Finally, we should calculate NPV and IRR for all projects in the same period (three years).

Note:  “All spreadsheets are available. The people, who are interested in having my spreadsheets (two Excel files included six sheets) of this case analysis as a template for further practice, do not hesitate to ask me by sending an email to: soleimani_gh@hotmail.com or call me on my cellphone: +98 9109250225. Please be informed these spreadsheets are not free of charge.”


Now, let me introduce you another method to find out the strategy implementation for the Value of Foods.

To be continued .......