Case StudyCarpe Diem Fund Management Ltd.A successful fund and investment management company, by the name of Carpe Diem Fund Management Ltd., had a good track record of choosing the right investments those that had positive returns - during the past number of years, through the middle of 2019. They were concerned about the stock markets volatility and wanted to begin diversifying so they would not be as susceptible to swings in the market as they had been in the past, and to hedge against the economic uncertainty they faced during the latter part of 2019. Top management was a competent group that consisted of several long term investors and traders in the market, but two of them had not had much formal education and training in financial analytical techniques that were being employed in the industry to support investment decision-making one of them frequently referred to his gut as the source of inspiration for making important decisions as in my gut is telling me.... However, they had decided to look at a number of direct investment opportunities, one of which they would purchase outright, to initiate the diversification strategy. Monica Moneybags, one of the primary financial analysts at Carpe Diem Fund Management Ltd., knew her education, training, and experience had put her in a good position to lead discussions and analysis concerning potential investments for the companys portfolio, but now she had to utilize some skills that she had not used since her finance courses in graduate school. Executive management at Carpe Diem had decided to make direct investments in a venture, rather than just purchasing stock or providing capital in other forms. They were looking at four different target acquisitions, and had to make decisions in the next several weeks. It was up to Monica to complete the analysis, share her work papers and justify her recommendations. This was going to be a challenge for her, because two of the top managers were street savvy but no formal training or education concerning a number of the financial analytical techniques that Monica was going to utilize. One of them, Albert Ross, focused almost entirely on net income gains and rates of increase, and would be difficult to convince if she were to use other analytical techniques, which he sometimes referred to as financial hocus-pocus and often would not listen to the rationale supporting the methodology.She had pulled together the basic information about the four proposals that were under consideration, and summarized them as follows:

Rev. Apr 2020 Ver. F Page 2 of 6Proposal 1This proposal was to purchase a company that rented and serviced mailing and office machines. The company had been in business for over 4 years and was well-run, but needed capital or a white knight to invest or purchase the operation. The initial cost totaled $600,000 and was to be depreciated over a period of 20 years (straight line). They projected sales of over $1.443 million during the next five years, and almost $775,000 in aftertax earnings. See Figure 1 below for the data to be used in the analysis.Figure 1 Financial Analysis of Proposal 1 Office MachinesProposal 1: Office Machines Initial InvstmtYear 1Year 2Year 3Year 4Year 5Net cost of new business$600,000 Incremental Revenue 91000170000263000394000525750Operating cost2650027000275002800028500Depreciation (straight line, 40 yrs)3000030000300003000030000Net increase in income34500113000205500336000467250 Less: Tax at 33 %113853729067815110880154193Increase in aftertax income2311575710137685225120313058Add back depreciation3000030000300003000030000Net cash flow for the period($600,000)53115105710167685255120343058Proposal 2The second proposal was to purchase a small plane to be located at a small executive airport nearby, and to be used by small business owners who had travel requirements that commercial airlines could not meet. These business operators were typically owners of growing and expanding businesses, and who needed to travel regionally on short notice. Other transportation alternatives such as commuter trains were not available and car services were too expensive and too slow (too much traffic). If

Rev. Apr 2020 Ver. F Page 3 of 6successful, this concept might be considered for expansion to other cities of similar size that had good growth track records for small businesses.Figure 2 Financial Analysis of Small plane/small airport shuttle serviceProposal 2 Small plane/small airport shuttle serviceInitial InvstmtYear 1Year 2Year 3Year 4Year 5Net cost of new business810000 Incremental Revenue 105000 202000 303000 445000 595000 Operating cost36000 39000 42000 44000 46000 Depreciation (units of production)121500 145800 153900162000 170100 Net increase in income(52500)17200107100 239000 378900 Less: Tax at 33 %(17325)567635343 78870 125037 Increase in aftertax income(35175)1152471757 160130 253863 Add back depreciation121500 145800 153900 162000 170100 Net cash flow for the period(810000)86325 157324 225657 322130 423963 Proposal 3The third proposal involved the purchase and use of motor scooters for a courier system in the inner city. It was expected to be very competitive with other similar services, and might grow into the type of operation that could be expanded to other cities of similar size, using a direct investment or franchise model. The initial investment was estimated to be $296,000. The revenues were expected to grow substantially during the first four years, and then to level off as a result of anticipated competition entering the market and driving down rates.Figure 3 Financial Analysis of Courier ServiceProposal 3: Intra-city courier serviceInitial InvstmtYear 1Year 2Year 3Year 4Year 5Net cost of new business296000 Incremental Revenue 42000 75900 111250 230500 159000 Operating cost10500 11000 11150 11250 11750

Rev. Apr 2020 Ver. F Page 4 of 6Depreciation (units of production)44400 65120 62160 62160 62160 Net increase in income(12900)(220)37940 157090 85090 Less: Tax at 33 %(4257)(73)12520 51840 28080 Increase in aftertax income(8643)(147)25420 105250 57010 Add back depreciation44400 65120 62160 62160 62160 Net cash flow for the period(296000)35757 64973 87580 167410 119170 Proposal 4The final proposal under consideration involved the utilization of small vehicles for deliveries in a metropolitan center. The plan was to purchase a number of them and use them to more easily maneuver in congested traffic in downtown areas, and the revenue during the first two years of operation was expected to be substantial. This really generated a lot of attention from Albert.Figure 4 Financial Analysis of Delivery ServiceProposal 4: Intra-city delivery serviceInitial InvstmtYear 1Year 2Year 3Year 4Year 5Net cost of new business513000 Incremental Revenue 379500 331050 88750 77400 52300 Operating cost45150 42750 27900 26700 25200 Depreciation (units of production)76950 112860 107730 107730 107730 Net increase in income257400 175440 (46880)(57030)(80630) Less: Tax at 33 %84942 57895 (15470)(18820)(26608)Increase in aftertax income172458 117545 (31410)(38210)(54022)Add back depreciation76950 112860 107730 107730 107730 Net cash flow for the period(513000)249408 230405 76320 69520 53708 The plan was to present the information about each proposal in summary, develop a thorough analysis using appropriate financial analytical techniques and methodologies, and to anticipate the questions and concerns that would arise during the discussions with the executive management group. The only constraints were related to the amount of funds they had available for investment they did not want to borrow at this juncture and that they could only support one project given the limited availability of

Rev. Apr 2020 Ver. F Page 5 of 6seasoned managers to run the project they ultimately chose. It had been determined that the cost of capital was 10% at the time, and that this rate should be used in any analysis.Monica knew that she should use at least three capital budgeting techniques:Payback (PB)Internal rate of return (IRR)Net present value (NPV)She was generally familiar with the techniques (she really wished she had given more attention to the capital budgeting techniques and rationale covered in her finance courses in her graduate degree program, but was reasonably confident that she could explain them clearly). She was more concerned that none of these would appeal to Albert, who had always been focused on accumulated earnings (increase in aftertax income). She had tried to convince Albert that the net present value method was the best approach, but he did not understand it and called it mumbo-jumbo and hocus-pocus finance. She nevertheless prepared her analysis and felt assured that she could convince the executive management group which project would be in the firms best interest and create the most value, and that Albert would listen to others if her presentation was clear and concise, and if the others understood.The calculations are presented in an attachment (spreadsheet) for your review and use.Case Questions1. Albert Ross admittedly focused on the level of earnings, and particularly the increase in aftertax income of each project (proposal). Which proposal do you think Ray will be focused on, and provide reasons/an explanation for your answer.f2. The first method Monica is to present is the payback technique. See the computations in the attachment (spreadsheet), and note the how PB is approximated using the proportion of the year to the nearest decimal place (i.e., 3.4 years).a. Which proposal should they select, given the requirements for the payback method?b. What are the primary disadvantages of this method, and why might it be appealing to an untrained investor?

Rev. Apr 2020 Ver. F Page 6 of 63. The next method Monica presented is the net present value (NPV) technique. Review the NPV calculated in the spreadsheet for each proposal and rank the proposals. Which proposal should be selected, based on the ranking? 4. The next method in her presentation is the internal rate of return (IRR). Rank the projects on the basis of their IRRs in the attached spreadsheet. a. Which proposal should they select, based on the criteria of IRR?b. What are the primary disadvantages of using the IRR method?c. If there were an unlimited capital budget, which projects should Carpe Diem invest in, based on the IRR criteria? d. If any are to be excluded, why?5. Do the IRR and NPV methods reject the same proposals? Discuss briefly.6. Given the limitations and recommendations from academicians, which proposal should you choose, and why?