4.2.1. 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 calculation¹⁸ 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
	0	1	2	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 ($)
	0	1	2	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 ($)
	1	2	3	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 ($)
	1	2	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.