Simulation model analysis and calculation
There are several methods and techniques I described above, there are judicial analyses and some methods of invest decision. But now I am going to consider three examples, three contracts which I should accept or reject. The terms of contracts are the following:
| Contract (project) | upfront payment | term of payment | term of delivery |
| I | - | Upfront payment | CEXW |
| II | 30% | L/C | FOB |
| III | 10% | L/C | СIF |
Table 4.1
Before I start to describe the projects I should make some assumptions. All of these contracts, which I am going to analyze, are located on the same market, for example European market. The basic price of goods is approximately equal, the price of good does not depend on term of payment in my example. The last assumption that is cash flows, which are created by contracts, are approximately equal too. I am going to concentrate on the way our financial methods and tools, described above, will work in practice. That is why I cut of quantity of variables.
The first contract: a buyer has just paid for the goods which have been taken from factory’s stock (CEXW). The first project has created negative as well as positive cash flows. There are sum of contract, cost of delivery, insurance, custom clearance. All risks are covered only by a buyer.
| Cash Flows $ | ||||||||
| Contract I (project) | ||||||||
| -300 | - 6, - 9 | - 45 | +90 | +140 | +150 | +130 | +80 |
Table 4.2
The second contract: a seller has not got the goods on stock and he has to produce the goods, but a seller needs the guarantee that is why a seller asks 30% of upfront payment. Another part of payment for goods comes when a seller produces the goods and loads them to the ship. The main parts of risks are still covered by buyer. The cash flows are:
| Cash Flows $ | ||||||||
| Contract II (project) | ||||||||
| -90 | -210, - 6, - 9 | - 45 | +90 | +140 | +150 | +130 | +80 |
Table 4.3
The third contract: a seller still needs upfront payment but 10% only. Another part of payment for goods is made by L/C. The L/C outstands when the goods are loaded to the ship. The L/C provides sharing the risks between a seller and a buyer. The parts have the agreement that the term of delivery will be the СIF and seller can receive the money after realizing the term of delivery. essential to cut down period of production and delivery. The project creates cash flows in the following way.
| Cash Flows $ | ||||||||
| Contract III (project) | ||||||||
| -30 | -270, - 45 | +90 | +140 | +150 | +130 | +80 | ||
Table 4.4
WACC as discount rate
Before I start my calculation I have to correct financial tools. There are periods which I use to estimate contracts monthly, but discount rate functions during a year. Here is a formula to avoid mistakes:
(4.3)
FV – future cash flow, i – discount rate for year, m, and n – how many times in one period the compound interest is calculated. I take WACC of company as discount rate for calculation. The WACC is (0.1226).
I would like to present the result of calculation[18] in table as following:
| I contract | II contract | III contract | |
| NPV | 229 919.45 | 229 925.62 | 244 573.83 |
| PI | 0.63866 | 0.63868 | 0.70891 |
| IRR | 11.35% | 13.15% | 20.36% |
| PP | 4.867 | 4.867 | 3.767 |
Table 4.5
4.2.2. Manager’s working capital use penalty points
As I show in Table 4.5 all three contracts have a positive NPV, but the third contract has the biggest one. Cause of this effect the third contract has the shortest period of time between the payments for goods and receiving it on buyer’s stock. I could reinforce this effect if I focused attention of managers on the period of time between prepayment or payment and receiving the goods. The calculation of penalty will depend on the term of delivery and term of payment. The manager will be encouraged when manager makes deal with less risky terms. In other words, manager has to organize covenant with less period of time between payment and receiving goods as possible. I could use data from predicted cash flow from Table (4.2, 4.3, and 4.4). Let’s focus on negative cash flow as it is presented below:
| Cash Flow | ||||
| Sum | ||||
| I contract | -300 | -15 | -45 | -360 |
Table 4.6
It is possible to see the terms of this covenant in Table 4.1(100% upfront payment is term of payment and term of delivery is CEXW). Please have a look at Figure (2.4 and 2.5) then it obviously that it means maximum risk for a buyer. The estimation of risks is equal 0.9 and 0.9 points.
The key factor, which I am concentrating on, is how much the company will earn if it doesn’t spend money for upfront payment. The Table 4.6 is transformed into table as below:
| Cash Flow ($) | ||||
| Sum | ||||
| Contract I | -45 | (-6; -9) | -300 | -360 |
Table 4.7
This table means that upfront payment can work for a company for three months, payment for insurance and delivery per month and customer monthly payment.
(4.4)
As a discount rate I should take the WACC of company. The WACC is the 0.1226. In the same way I use formula’s (4.3) and NPV formula:
44,998.68 + 14,999.13 + 299,973.84 = 359,971.65
The Table 4.2 is provided the summarize the spending of covenant, and it consist 360,000.00. After that preparation I can calculate the NPV, but it won’t be real NPV it is up-side down NPV:
Penalty Point of Contract I (up-side down NPV) = - 360,000.00 + 359,971.65 = -28.35
This figure (-28.35) is the penalty point of manager, who completes Contract I. In the same way, I calculate the penalty point of Contract II, and Contract III. The Table 4.3 helps me to estimate the negative cash flows of Contract II:
| Cash Flow ($) | ||||
| Sum | ||||
| Contract II | -45 | -225 | -90 | -360 |
Table 4.8
44,998.68 + 224,987.01 + 89,992.17 = 359,997.86
Penalty Points of Contract II = - 360,000.00 +359,997.00 = - 22.14
This figure (-22.14) is the penalty point of manager, who completes Contract II. The Table 4.4 shows the negative cash flows of Contract III:
| Cash Flow ($) | |||
| Sum | |||
| Contract III | -315 | -30 | -345 |
314,990.74 + 29,998.27 = 344,989.01
Penalty Points of Contract III = - 345,000.00 + 344,989.01 = - 10.99
In the end, I can just summarize the main result of my calculation in table:
| Contract I | Contract II | Contract III | |
| Penalty Points | -28.35 | -22.14 | -10.99 |
| Buyer’s risk of delivery | 0.9 | 0.47 | 0.37 |
| Buyer’s risk of payments | 0.9 | (0.3x0.9+0.7x0.5) =0.62 | (0.1x0.9+0.9x0.5) =0.54 |
Table 4.10
I calculate the figures risk of payment as weighted average of risks for every part of payment according to the contract. I estimated the risk by using the Figure 2.4 and 2.5. For example, the payment in Contract II is divided into two parts. The first upfront payment is 30 %, the second one is 70%, but the second payment gives less risk techniques for a buyer by L/C. And I calculate the weighted average volume of risk of all payment in Contract II.