Accounting and profitability Projects and investing
Projects and investing Case-examples
Production as a part of value chain
Production processes and production control
Production systems and organizations
Creating value In this exercise:
• Project to establish a factory • Investment project • Job assignment and project network • Risk management • Return on investment
• Initial investment and cost of capital • Net present value (NPV) In this exercise:
• Project to establish a factory • Investment project • Job assignment and project network • Risk management • Return on investment
• Initial investment and cost of capital • Net present value (NPV) Investment in production system: BMW Mexico
Kuva: https://eu.usatoday.com/story/money/cars/2016/06/17/bmw-moves-forward-new-plant-mexico/86010572/ Project to establish a factory
• In 2014, BMW announced the establishment of a car factory in Mexico • The factory opened in June 2019 • The factory is expected to produce approximately 175,000 BMW 3 Series vehicles per year • An important factor for the investment was the low cost and the region's potential in car production • Mexico is the world's fourth largest car exporter • Increased investment in Mexican auto production • Daimler and Audi established their own car factories in Mexico in 2013 • What should be considered when setting up a factory and is it economically viable to set up a factory?
Financial Times (2014). BMW to build $1bn car plant in Mexico. July 3, 2014. [Viitattu 6.8.2019]. Saatavissa: https://www.ft.com/content/a55925c0-02c4-11e4-a68d- 00144feab7de Automotive News (2019). BMW opens Mexico plant without flinching. June 10, 2019. [Viitattu 6.8.2019]. Saatavissa: https://www.autonews.com/manufacturing/bmw-opens- mexico-plant-without-flinching Reuters (2019). BMW wants clear guidance from Mexico government for investment plans. [Viitattu 6.8.2019]. Saatavissa: https://www.reuters.com/article/us-mexico-bmw/bmw- wants-clear-guidance-from-mexico-government-for-investment-plans-idUSKCN1QM2F1 An investment project to establish a factory
• There are three dimensions to be defined in the factory establishment project
• Limited scope, i.e. what is procured
• Limited time, i.e. how long it takes to set up a factory
• Limited costs, i.e. how much capital is available for the project An investment project to establish a factory
• A company usually has many different options for implementing a project
• There are many builders, equipment suppliers and financiers in the market
• Investment can be financed with equity or debt
• They both have a certain 'cost', meaning how much return on capital is needed
• An investment project requires planning and negotiations between suppliers and the customer
• Bidding, contract negotiation and establishment of a project organization In this exercise:
• Project to establish a factory • Investment project • Job assignment and project network • Risk management • Return on investment
• Initial investment and cost of capital • Net present value (NPV) Job assignment and project network
• The tasks required to complete the project and the order in which they are carried out can be illustrated with a project network
• The project network indicates the tasks required to complete the project, their duration, flexibility, and the critical path
• The tasks required to complete the task are obtained through work assignment
• The project is divided into smaller sections
• Certain tasks can be performed simultaneously, which increases flexibility In this exercise:
• Project to establish a factory • Investment project • Job assignment and project network • Risk management • Return on investment
• Initial investment and cost of capital • Net present value (NPV) Risk management
• Projects involve risks, that is, events that affect the cost, schedule or scale of a project
• Risks need to be identified and assessed, and measures to avoid them must be planned
• Risks can be classified • Operational risks • Business risks • Financial risks • Regional risks Risks of setting up a factory
• Operational risks • Accidents at work, machine failures, fires • Business risks • Production capacity, quality of equipment and other of the completed factory, competence project organization could be worse than anticipated • Financial risks • The cash flow from the factory could be worse than anticipated, the change in the peso's value against other currencies • Regional risks • Restrictions on trade with the United States, earthquakes An example of the risks at the BMW factory In this exercise:
• Project to establish a factory • Investment project • Job assignment and project network • Risk management • Return on investment
• Initial investment and cost of capital • Net present value (NPV) Evaluation of return on investment
• The profitability of an investment can be assessed by its investment costs, cash flow from the investment and cost of capital
• Common methods used to assess the profitability of an investment are:
• Net present value (NPV)
• Internal rate of interest (IRR)
• Payback period Initial investment and cash flow
• BWM factory’s Initial Investment was 1 Billion US ($ 1,000,000,000)
• Most production facilities operate for an average of 10 years
• One 3-Series car costs around $ 40 000
• Taxes are ignored for simplicity
• Car manufacturers receive an average of 6% margin on one car sold
• Suppose the customer pays for the car immediately upon purchase
• Suppose the cost of the factory to be $ 100 000 000 a year
• If the factory produces 150,000 cars a year, then the annual free cash flow will be ퟏퟓퟎ ퟎퟎퟎ ∗ $ퟒퟎ ퟎퟎퟎ ∗ ퟔ % − $ퟏퟎퟎ ퟎퟎퟎ ퟎퟎퟎ = $ퟐퟔퟎ ퟎퟎퟎ ퟎퟎퟎ
Statistics Canada (2007). Manufaturing plants have short lives. [Viitattu 6.8.2019]. Saatavissa: https://www150.statcan.gc.ca/n1/pub/11-402- x/2007/4005/grafx/htm/ceb4005_002_5-eng.htm • The average capital cost of investment in the automotive industry is about 7.6%
• Weighted Average Cost of Capital, WACC
• Money is more valuable today than in the future
• Capital has a 'cost'
• If money is available right away, it can make a profit
• The present value of future cash flows is obtained by discounting
KPMG (2017). Cost of Capital Study 2017. [Viitattu 6.8.2019]. Saatavissa: https://assets.kpmg/content/dam/kpmg/ch/pdf/cost-of-capital-study-2017-en.pdf In this exercise:
• Project to establish a factory • Investment project • Job assignment and project network • Risk management • Return on investment
• Initial investment and cost of capital • Net present value (NPV) Net present value (NPV)
• NPV will help you evaluate the return on investment • However, NPV does not tell you the exact value of the investment!
• NPV factors in the timing of cash flows
• In general, the investment is profitable if the NPV is positive • The net present value is calculated: ퟏퟎ 퐅퐂퐅 퐍퐏퐕 = 풕 ퟏ + 퐫 풕 풕=ퟎ 퐖퐀퐂퐂 NPV
• NPV is the sum of discounted cash flows • The table below lists free cash flows and their discounted values • Year 0 includes only the initial investment • NPV is approximately $ 721.7 million • NPV gets a positive value • That is, along with the NPV rule, the investment is profitable Week 5 assignment: Project plan and return on investment
1. Founding a business(1-2 pages) • Make a project network about creation of your business - Network tasks may include obtaining business spaces, recruiting, etc. - There must be flexibility in your project network, i.e. tasks of different lengths can be performed at the same time. - Mark the critical path - Explain briefly the tasks of your project network • What are the risks involved in setting up your business and how can you be prepared for them? 2. Evaluating Return on Investment (Excel file) • Estimate your initial investment in euros - -Initial investment includes equipment, facilities and other procurements to start a business • Estimate your company's free cash flow for years 0–4 - Year 0 includes only the initial investment In years 1-4, business is conducted normally • Calculate the net present value of your investment using 10% average cost of capital (WACC = 10%) - Is the investment profitable? Week 5 assignment: Project plan and return on investment
• Return Excel-file and text part as a pdf to myCourses. The weekly assignment must be returned not later than 5 days after your weekly exercise by 4:00 pm
• Remember to give feedback: 1. How long did it take to do the assignment? 2. What new did you learn? 3. What should be developed in this exercise? 4. General comments on the course so far?
Next week we will discuss accounting and profitability