Fondiaria Spa

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Date Submitted: 11/23/2012 03:18 PM

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Discounted cash flow analysis is a method used to evaluate the profitability of an investment. It is based on a basic financial principle: a dollar today is worth more than a dollar tomorrow. This principle is referred to as the Time Value of Money, which simply states that money loses value over time.

To evaluate the profitability of an investment, all the future cash flow deriving from the investment are discounted by the rate of return offered by a risk-equivalent investment in financial market.

The Discounted Cash Flow (DCF) formula is:

DCF = CF1/(1+r)1 + CF2/(1+r)2 + CF3/(1+r)3 ...+ CFn/(1+r)n

CF refers to the cash flow in different periods, while r is the rate of return.

To find the net present value (NPV) of the investment, it is necessary to sum all the future cash flows, ingoing and outgoing. A positive NPV indicates that the investment is worth taking.

NPV = C + C1/(1+r) + C2/(1+r) 2 + Cⁿ/(1+r)ⁿ

In the case of Fondiaria Torino S.P.A., to analyze the profitability of the investment - the acquisition of a new machine, we considered as cash inflow the savings deriving for the company from the Vulcan Mold-Maker and as cash outflow the capital expenditure for the new device (equal to the initial cost minus the sales of the old machines and the tax savings) for a six-year period, after which the company would have to replace the old machines. The value of cash inflow has been calculated through the difference between the operating cost (including labor costs, maintenance and annual depreciation) of the new and the old machine net of tax and depreciation. As discount rate we considered the weighted average cost of capital (WACC), which is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC has been calculated as the sum of the percentage of debt (33%) multiplied by the interest rate (6.8%) and the percentage of equity (67%) multiplied by the required rate...