Executive Summary of FLIR Systems Commercial company

The aim of this paper is to provide deep insights regarding the project appraisal and whether the FLIR corporation should invest in the project or not. A critical financial statement analysis have been performed to evaluate financial condition of the organization. The WACC of company is calculated as the weighted average cost of the debt and the equity. For taking the weight we have used the market value of the debt and equity as per the latest financial statement published by the company for the Q2FY18. The financial ratio analysis indicate positive liquidity position of the organization. The current ratio in the year 2015 was 2.20 which increase and become 3.51 in the year 2017. The ROA of the corporation has decreases which indicates that the profitability of the organization is decreasing. The inventory turnover has also show decline which is sign of decrease in the amount of sales. The gross margin ratio however did not show much fluctuation over the respective period. Based on the analysis below, we don’t recommend investing in the project as it has negative NPV and IRR lower than the cost of capital. The Net present value is an indicator of profitability which shows whether the project will generate profit in the future or not. The NPV is among the most commonly used approach to evaluate the profitability of a project.

Part 1

Financial statement analysis of FLIR Systems Commercial company

The above shows the income statement of the FLIR organization. Through the income statement it can be seen that the net profit of the corporation has decreased significantly. The net income was 16% of the revenues which decrease up to 6% in the year 2017.  Despite the increase in revenues the corporation unable to enhance its profitability due to excessive increase in expenditures (SINHA, 2012).

Through analyzing the balance sheet of the FLIR Corporation it can be seen that the total current assets of the organization has increased significantly. The amount of equity and total assets also increased over the three year period. The increase in the assets of the corporation indicates growth of the organization and it can be said that in upcoming years the organization will able to generate profit (Fridson & Alvarez, 2011).

Fore-casted Financial Statements of FLIR Systems Commercial company

The forecasted financial statements of the FLIR organization indicates that the investment in the new product line would not generate significant amount of profit which becomes the reason for decreased revenue. The forecasted income statement is presented in the Appendix 1 of the report. The balance sheet of the organization is presented in the Appendix 2 of the report.

Fore-casted Free Cash Flows of FLIR Systems Commercial company

Financial Ratio Analysis of FLIR Systems Commercial company

The financial ratio analysis indicate positive liquidity position of the organization. The current ratio in the year 2015 was 2.20 which increase and become 3.51 in the year 2017. The ROA of the corporation has decreases which indicates that the profitability of the organization is decreasing. The inventory turnover has also show decline which is sign of decrease in the amount of sales. The gross margin ratio however did not show much fluctuation over the respective period (Fridson & Alvarez, 2011).

Part 2

WACC of FLIR Systems Commercial company

The WACC of company is calculated as the weighted average cost of the debt and the equity. For taking the weight we have used the market value of the debt and equity as per the latest financial statement published by the company for the Q2FY18. WACC is the minimum hurdle rate that the project needs to achieve to generate the minimum required return for the company.  Therefore the calculation of WACC is very important aspect in the capital budgeting and need to be evaluated very carefully. For calculating the WACC we need the cost of debt, cost of equity, book value of the debt and equity for calculating the weighted WACC.

WACC is calculated as

WACC = E/V* Re + D/V*Rd*(1-Tc)

Where:

Re = cost of equity

Rd = cost of debt

E = Book value of the firm's equity

D = Book value of the firm's debt

V = E + D = total book value of the firm’s capital

E/V = percentage of capital that is equity

D/V = percentage of capital that is debt

Tc = corporate tax rate

Cost of equity of FLIR Systems Commercial company

The cost of equity for FLIR is calculated using the CAPM model in which we have the taken the beta, risk free return and an assumed market risk premium of 8%.

The cost of equity using the dividend discount model is calculated as below

Risk free return + beta * market risk premiums

3.24% + 0.59*8%

= 7.96%

Cost of debt of FLIR Systems Commercial company

After this we have calculated the cost of debt using the debt figure given in the financial statement of the company. As per that the company has debt outstanding with annual coupon of 3.125% and market value of $421 million (Higgins, 2007).

The cost of debt would be equal to the YTM of the bond outstanding, which can equate the present value of the future payment on the bond equal to the market price of the bond. Therefore using this equation we have calculated the YTM of the bond at 3.125% (Fridson & Alvarez, 2011).

As at this YTM the present value of the future cash flows from the bond is equal to the current market price of the bond (Higgins, 2007).

Also the interest on the debt is tax deductible; therefore we have to take the tax adjusted cost of debt. The average tax rate is calculated as the tax rate paid by the company in its latest financial statement and using the equation

Income tax expense/Pre-tax income

The company average tax rate is approximately 13.7%.

Post tax cost of debt = 3.125%* (1- 13.7%) = 2.70%

Therefore after calculating all the cost we can calculate the WACC of the company as given below

As the proportion of equity is higher, therefore the WACC is very close to the cost of equity.

Net Present Value (NPV), Internal Rate of Returns (IRR), Payback Period (PP), MIRR and Profitability index

After the WACC we need to analyze the project cash flows and assess the viability of the project with the project WACC.  For any project to be acceptable the project cash flows need to generate positive NPV and an IRR higher than the WACC and the discounted payback period should be less than the project life so that the project cash flows are recovered well before the project ends (Pandey, 2015).

Analysis of FLIR Systems Commercial company

As per the calculation above the project has NPV of ($1997) with the existing capital structure and NPV of ($694) with the target capital structure and in both the cases the IRR and MIRR are lower than the WACC calculated (Melville, 2017).

However all the method being chosen above has certain drawbacks also, like NPV is based on certain assumptions which include the discount rate, initial investment, sale and cost estimates. Therefore management should spend considerable time in estimating these variables and the future cash flows. Similarly the IRR is based on the assumption that the future cash flows are reinvested at the IRR of the project, which is not possible in certain cases and therefore may be change in the future reinvestment rate and therefore the project IRR will be lower than the estimated IRR. Similarly the payback period doesn’t consider the cash flow beyond the payback period and doesn’t tell about the profitability of the project and how much cash flow will be available after the payback period (Pandey, 2015).

Project Recommendation of FLIR Systems Commercial company

Based on the analysis below, we don’t recommend investing in the project as it has negative NPV and IRR lower than the cost of capital. The Net present value is an indicator of profitability which shows whether the project will generate profit in the future or not. The NPV is among the most commonly used approach to evaluate the profitability of a project. The negative NPV is indicating that investing in this project would not be a good idea because the project will not generate profit and the corporation will have to face financial loss if they are going to invest in this project (Christoffersen, 2011).

The IRR of the project is also lower than the cost of capital which means that the cost is higher than return. Moreover the financial statements analysis have shown that the organization profitability is decreasing which means that the organization should focus on increasing its profitability. It is not a suitable time for the corporation to invest in a major project because the financial condition of the organization needs improvement. Furthermore such projects should be selected which generate profit in the future. It is recommended that the organization should hire new financial analyst which would help them to improve their financial condition.

Risk Analysis of FLIR Systems Commercial company

There are several risk which are related to a new project. The economic conditions, financial situation of the organizations, the taste & preferences of the customers and market trends all of these factors have impact on the project and create risks. It is important for the top management of the corporation to identify the risks and prepare risk mitigation strategy during the planning phase of the project (Atrill, 2014).

Conclusion of FLIR Systems Commercial company

Based on all above analysis, projected cash flow of the project, we believe that the management should not take this project as it has negative NPV ad lower IRR and this project will not add any value to the company shareholders. The Net present value is an indicator of profitability which shows whether the project will generate profit in the future or not. The NPV is among the most commonly used approach to evaluate the profitability of a project. The negative NPV is indicating that investing in this project would not be a good idea because the project will not generate profit and the corporation will have to face financial loss if they are going to invest in this project.

Moreover the financial statements analysis have shown that the organization profitability is decreasing which means that the organization should focus on increasing its profitability. It is not a suitable time for the corporation to invest in a major project because the financial condition of the organization needs improvement. Furthermore such projects should be selected which generate profit in the future. It is recommended that the organization should hire new financial analyst which would help them to improve their financial condition.

References of FLIR Systems Commercial company

Atrill, P. (2014). Financial Management for Decision Makers (7 ed.). Pearson Higher Ed.

Christoffersen, P. (2011). Elements of Financial Risk Management. Academic Press.

Fridson, M. S., & Alvarez, F. (2011). Financial Statement Analysis: A Practitioner's Guide. John Wiley & Sons.

Higgins. (2007). Analysis for Financial Management. Tata McGraw-Hill Education.

Melville, A. (2017). International Financial Reporting: A Practical Guide (6 ed.). Pearson Higher Ed.

Pandey, I. (2015). Financial Management. Vikas Publishing House.

SINHA, G. (2012). FINANCIAL STATEMENT ANALYSIS . PHI Learning Pvt. Ltd.

Appendix 1

Appendix 2