Hand out date 1 March, 2012
Hand in date 18 May, 2012
Assessment 50%
Daubek Ismailov
TP026716
UC3F1107AF
Table of Contents PART A 2 PART B 3 Net Present Value 4 Profitability Index 5 Payback Period 8 Internal Rate of Return 9 SUMMARY OF THE DEVELOPED FINANCIAL MODEL 10 REFERENCES 11
PART A
Financial modeling is useful tool in today’s business world. Investopedia (2012) defines financial modeling as “the process by which a firm constructs a financial representation of some, or all, aspects of the firm or given security. The model is usually characterized by performing calculations, and makes recommendations based on that information”. It is crucial for companies to use financial modeling during developing a new business project.
A financial model can show whether a future project will be profitable or not, how much money it needs to invest, will it be need for investing some other additional investments and what is the sum of these future investments. What are the future cash inflows and outflows will be in each particular year from the implementing year. In what period investors will be able to get their invested money back. For the managers it will be seen future balance sheet, income statement and statement of cash flow. Due to different economic and other reasons and factors in financial market it is always uncertainty and risks of implementing of a project. Managers cannot be totally sure in successfulness of a project. So that is why a model may show different scenarios of a future project. For example, what will be total profit after five years if project will be 100% successful, or what is the profit or losses in 5 years if project will be not 100% successful? So it will show all the numbers in, for instance, three different scenarios as poor, good and boom. Financial modeling is used by four categories of people (Vershinina, 2010). First are creditors. They use financial modeling to decide give a loan or not, second are investors. Models help them to determine effectiveness and risks of a project and decide to participate or not. Another group is managers. Modeling is useful for them to make decision about choosing and implementing the best project among other alternatives. The last group is sole-proprietorships which use modeling to check whether their ideas are realistic, rational and economically effective.
Since financial model is just proposed plan of a business project it helps to eliminate any future losses by preventing from implementation if the project will be not profitable. Moreover, it is costs almost nothing in term of money to develop financial model of a project. According to Benninga (2000), financial modeling can also determine a profitability of some other financial tools, for example bond issuing, leasing and other.
PART B
As it was mentioned in previous part financial modeling is a crucial tool during proposing and choosing a future project. There are four fundamental calculations in financial modeling which are very helpful to determine profitability and successfulness of a project; they are net present value, internal rate of return, profitability index and payback period. This model will assist greatly to financial advisors in their daily working force to serve customers’ needs. To explained and illustrate how this model work let assume that there is a company ABC. Managers of this company are planning to introduce the company with a new project. They already calculated how much initial investment required, what the future cash flows are and what is the discount rate of a project. Initial investment is $500,000; future cash flows in year one is $90,000, year two is $110,000, year three is $160,000, year four is $210,000 and year five is $200,000; interest rate is 10%. Managers want our financial institution help them to determine whether it will be profitable project or not in next five
