List of Acronyms

WACC - Weighted Average Cost of Capital

PV- Present Value

NPV- Net present Value

PBP - Payback Period

IN - Initial Investment

Executive Summary

Capital investments often require meticulous evaluation to make appropriate decisions on which projects or investments to implement. However, before a company can decide to make such capital investments, it requires identifying the best source of capital to use. The field of financial management provides us with various frameworks that are essential in making the above decisions. This essay will, therefore, use the three metrics NPV, PBP, and IRR in determining the best investment projects that can be selected by Genesis Energy Company.

Introduction

The best source of capital is identified by calculating the weighted average cost of capital (WACC) which incorporates different capital sources of a company. Once the optimal cost of capital is determined, capital budgeting then follows (Jorgenson & Yun, 2001). In capital budgeting, the various investment options are identified. The approaches of NPV, PBP, and IRR are used to gauge and rank the viability of each alternative. The above methods have been used for capital planning by Genesis Energy.

Genesis Energy Plan Capital Report

Different criteria are applied when evaluating an investment which includes the PBP NPV, and the IRR. These approaches are applied differently whereby some of them incorporate the time value of money concept while others do not (Knott, 2004). The net present value method utilizes the time value of money concept by discounting the expected future returns from an investment. The PBP method evaluates the period that an investment will take for it to be breakeven using the estimated future cash influence.

Calculation WACC

WACC is used to calculate the cost of capital of a company by proportionately assigning different weights to various sources of capital. This approach evaluates all sources of capital of a company which includes shareholders equity, preference shares, long-term debt, bonds, and debentures among others. WACC calculation involves multiplying the weights of each item that is contributing to the capital structure with the cost of capital. Companies usually have varying capital structures mainly composed of equity and debts.

Genesis Energy has a total debt of $ 1.7 million whereas the amount of equity capital is $2 million. Therefore, the total capital of Genesis at $3.7 million. The proportion of debt capital, in this case, is 46% whereas the percentage of equity capital is 54%. The cost of equity finance incurred by Genesis is 2%. On the other hand, the cost of debt finance stands at 6.59%. WACC uses these weights to estimate the average capital cost of Genesis.

The proportion of obligation * cost of the obligation= Weighted cost of the financial obligation (Jorgenson & Yun, 2001).

Weighted cost of debt=6.59*46%= 3.03

Weighted cost of equity capital = 2*54% = 1.08

WACC is derived by getting the total of all the weighted costs calculated above.

WACC=3.03 + 1.08= 4.11

The weighted average cost of capital for genesis energy is 4.11%.

Metrics Used

The three identified methods of measuring investments are ranked according to their appropriateness. Net present value (NPV) will be given the priority (Moloney, 2014). For a project to qualify, it must have a positive NPV failure to which it will be automatically rejected. The project will rank as per the NPV with the highest coming first. The project to be picked in this approach will be the one with the highest NPV.

The internal rate of return (IRR) approach will then follow. IRR will help us identify the rates of return for each project. The investment with the highest IRR is deemed to be most viable (Busch & Ferrarini, 2017). The rate of return is also used in calculating NPV. The payback period method will get the last.

Recommendations

The above metrics will guide the selection of the project to be implemented by Genesis capital. Three key factors will be considered. These include the facility, the equipment as well as the inspection. The recommendations are further elaborated down below.

Facility

Project A requires an initial investment of $2000. Project B requires an investment of $2500. Finally, project C requires an initial investment of $3000.The calculation for this approach will be calculated for ten years. The calculations of NPV are broken down in table 1 below.

Table 1: The Use of NPV Approach

By applying the NPV project, C is recognized as the most desirable.

Table 2: The Use of IRR Approach

By applying the IRR approach, project C will be the most viable investment for Genesis energy.

Table 3: The Use of the Payback Period Method

These criteria show that project C and project B have a shorter payback period of seven years. This period is the time that Genesis capital will take to recover its initial investment for each of the projects.

Equipment

Genesis Energy is considering three different levels of equipment to invest in this. These types of equipment will be referred to as equipment 1, 2, and 3. Each category of equipment has different specifications.

Equipment 1

Equipment 1 has three different variations. These variations include manual, automatic, and semiautomatic. The NPV, IRR, and PBP are outlined in the table below.

Table 4: The Breakdown of NPV, IRR, and PBP of Equipment 1 for Each Variation

From this analysis, the manual equipment has the highest NPV of $ 2683, the highest IRR of 33.35% as well as the shortest PBP of 5 years. The automatic equipment has an NPV of 2081, PBP of 6 years and an IRR of 17.95%. Finally, the semi-automatic equipment has an NPV of 1630, the highest IRR of 19% and PBP of 6years.

From these findings, the manual equipment is the most viable equipment for genesis to invest in.

Equipment 2

There are two variations of equipment two which include the standard and topline. The PBP, NPV, and IRR are broken down in the following table.

Table 5: the NPV, IRR, and PBP of equipment 2

The top of the line equipment qualifies based on the metrics of NPV and IRR but it takes more time to recoup its initial investment than the other equipment. The top of the line equipment has a more PV of $4932, a higher IRR of 28.87%, but a longer PBP of 6 years. The top of the line equipment will, therefore, be the most preferable and will be selected for the investment.

Equipment 3

This level of equipment is to be analyzed based on person-hour requirement. There are three different options to be considered, which includes a two-man machine, three man-machine as well as five man-machine.

Table 6: The Breakdown of NPV, IRR, and PBP of Equipment 3

The machines under the third category of equipment all have a negative NPV. The IRR of all the equipment is also negative. The items of equipment are also not able to meet the initial investment cost as observed that they are unable to break even. This shows that they lack viability as the investment and other subsequent costs outweigh the expected cash inflows (Busch & Ferrarini, 2017).

All machines in this category fail the viability test, and therefore, none of them should be picked.

Inspection

Inspection is an important aspect of Genesis Energy’s operations. The mode to be used for inspection can either be in-house or by contract. The initial investment cost for in-house inspection is $1800 whereas a contract inspection has no initial investment cost. These two options are analyzed in table 7 below.

Table 7: Comparison of in-house inspection vs. contract inspection

If the company needs value it should select the contract inspection, but it will yield greater returns, it also has an infinite IRR. The PBP of the contact inspection method is at the beginning of the inspection exercise.

Total Investment Cost

After analyzing each of the above aspects, the investment options that are most viable and should be implemented by Genesis Energy have been identified. This combination is summarized in table 8 below.

Table 8: Combination of selected investment options

The selected combination will have a total investment cost of $7050. The combined NPV is $5258, a payback period of 6 years and an IRR of 22.46%.

Conclusion

An investment activity for any company is usually a capital-intensive exercise that requires informed decision-making. There is also a degree of risk involved which has to be compensated for by reasonable returns. The major approaches that have been used for evaluation of the investments of Genesis energy include IRR, NPV, and PBP. The investment options identified include the use of facility C because it maximizes value and has a higher return, manual equipment one because it has the highest net present value.

References

1. Busch, D., & Ferrarini, G. (ed.) (2017). Regulation of the EU financial markets. Oxford, UK: Oxford UP
2. Jorgenson, D.W., & Yun, K.-Y. (2001). Investment. Cambridge, MA: MIT Press.
3. Knott, G. (2004). Financial management. Basingstoke, UK: Palgrave Macmillan.
4. Moloney, Niamh. (2014). EU securities and financial markets regulation. Oxford, UK: Oxford European Union Law Library.