...Evident within the analysis of financial management is the goal of maximising shareholder wealth. Pertaining to this goal is the methodology of capital budgeting, referred to as Net Present Value analysis(NPV). This concept evaluates a capital investment project measuring the difference between its cost and the present value of its expected cash flows (Parrino et al. 2014, p.339). More simply, the NPV tell us the amount by which the benefits from a capital expenditure exceed its costs (Parrino et al. 2014, p.339). Along with any valuation method for a capital project are associated advantages and disadvantages essential to determining its relevance when compared with other methods of analysis. The advantages of NPV include, but are not limited to: the inclusion and importance of the 'time value of money (Accounting-Management 2014),' consideration of cash flows before, during and after a business venture, consistency with financial management goals and the high priority of profitability and risk involved in capital investment (Accounting-Management 2014). The inclusion of the time value of money is the most notable advantage of NPV supported by the notion, 'a dollar today is worth more than a dollar in the future (Investopedia 2014).' Present currency holds more value due to three reasons, accruing interest on investments, future money is subject to inflation and finally there is always the risk of not receiving promised money (Investopedia 2014). An organisation is unlikely...
Words: 681 - Pages: 3
...BUS 630 Week 6 DQ 2 Net Present Value Analysis To Buy This material Click below link http://www.uoptutors.com/BUS-630/BUS-630-Week-6-DQ-2-Net-Present-Value-Analysis Complete the following exercise, using this Excel template, and respond to at least two of your fellow students’ postings.. In eight years, Kent Duncan will retire. He is exploring the possibility of opening a self-service car wash. The car wash could be managed in the free time he has available from his regular occupation, and it could be closed easily when he retires. After careful study, Mr. Duncan has determined the following: * A building in which a car wash could be installed is available under an eight-year lease at a cost of $1,700 per month. * Purchase and installation costs of equipment would total $200,000. In eight years the equipment could be sold for about 10% of its original cost. * An investment of an additional $2,000 would be required to cover working capital needs for cleaning supplies, change funds, and so forth. After. eight years, this working capital would be released for investment elsewhere. * Both a wash and a vacuum service would be offered with a wash costing $2.00 and the vacuum costing $1.00 per use. * The only variable costs associated with the operation would be 20 cents per wash for water and 10 cents per use of the vacuum for electricity. * In addition to rent, monthly costs of operation would be: cleaning, $450; insurance, $75; and maintenance, $500. ...
Words: 396 - Pages: 2
...the vessel loaded and unloaded. Ocean Carriers supplied a vessel that complied with internal regulations and manned the vessel with a qualified crew. Additionally, Ocean Carriers ensured adequate supplies and stores onboard, supplied lubricating oils, scheduled the repairs, conducted overall maintenance of the vessel, and placed all insurances for the vessel. Need for Analysis In 2001, Ocean Carriers was in a predicament and it was essential that the company conduct detailed analysis before making major decisions. Ocean Carriers was in negotiations with a charterer for a three-year time charter starting in 2003, but the vessels in Ocean Carriers’ current fleet could not commit to a time charter beginning in 2003. The company’s ships were either already leased during that period or were too small to meet the customer’s needs. It is also noteworthy that there were no sufficiently large capsizes available in the second-hand market. Ocean Carriers had to decide how to handle this situation with the charterer and thorough analysis was certainly necessary. General Recommendation We have conducted our own analysis of Ocean Carriers and we have determined that the company should have terminated the negotiation with the charterer and avoid involvement in the project. Problem Confronting Ocean Carriers The major dilemma facing Ocean Carriers in 2001 was whether or not they should commission a brand new 180,000 deadweight ton ship for delivery in early...
Words: 670 - Pages: 3
...advantage: how does the proposed solution create value? A. How does the proposed solution create value for the firm? Identify and discuss sources of value and risk B. How does the proposed solution create value to the customers? Identify and discuss sources of value and risk C. How does the proposed solution differentiate from competing products? Identify and discuss sources of value and risk Note: At a minimum include issues related to brand value and cannibalization. C. Financial feasibility analysis List all major assumptions (they should relate to your analyses in sections A and B) for your “most likely” scenario. Describe the cash outflows and inflows associated with the proposed solution. a. Perform a break-even analysis How much does the firm need to sell in order to break-even? Is it feasible to break-even within the desired time frame? b. Construct a cash flow diagram The cash flow diagram should contain all the costs (split them out) and the expected revenues/contribution. Include net cash flow, cumulative net cash flow, and present values (see cash flow table example). Note: make sure to include the potential loss in MM lager contribution due to cannibalization. c. Use the cash flow diagram to calculate the (discounted) Payback period, Net Present Value, and Internal Rate of Return D. Risks & uncertainties Identify which assumptions are most sensitive and how changes influence the financial analysis. Perform a sensitivity analysis and create a worst case and best case scenario...
Words: 370 - Pages: 2
...Guillermo Furniture Store Analysis Fin571 Guillermo Furniture Store Analysis Guillermo Furniture Store (Guillermo) is a manufacturer of furniture located in Sonora, Mexico and is the largest industrial furniture manufacturer in the area. Guillermo has investment opportunities but must consider past and current choices. Guillermo Navallez, the owner of Guillermo’s Furniture store, has been experiencing a slowdown of business, primarily due to the increase in competition. Due to the changes in the operating environment, Guillermo must find an alternative investment opportunity. Regardless of the opportunities available, the value of each is determined by the net present value they offer. This paper, which will include the evaluation of finance concepts from the readings, will identify which alternative is necessary to improve business. It will include an evaluation of possible changes and demonstrate how capital budget analysis can provide the necessary information for the best possible return on investment. However, due to the competition Guillermo is in a situation, which requires an evaluation of processes and find ways to compete. With more competitors in the market, the labor costs have increased but at the same time, the competitors have introduced techniques that lower production costs. These changes have decreased Guillermo's profit margins significantly, but Guillermo can use capital budgeting to increase the profit margins. The geographical location of...
Words: 1118 - Pages: 5
...Discounted Cash Flow (DCF) Analysis Precedent Transactions AnalysisUnlevered Free Cash Flow The discounted cash flow (DCF) analysis represents the net present value (NPV) of projected cash flows available to all providers of capital, net of the cash needed to be invested for generating the projected growth. The concept of DCF valuation is based on the principle that the value of a business or asset is inherently based on its ability to generate cash flows for the providers of capital. To that extent, the DCF relies more on the fundamental expectations of the business than on public market factors or historical precedents, and it is a more theoretical approach relying on numerous assumptions. A DCF analysis yields the overall value of a business (i.e. enterprise value), including both debt and equity. Download DCF Analysis Template Key Components of a DCF * Free cash flow (FCF) – Cash generated by the assets of the business (tangible and intangible) available for distribution to all providers of capital. FCF is often referred to as unlevered free cash flow, as it represents cash flow available to all providers of capital and is not affected by the capital structure of the business. * Terminal value (TV) – Value at the end of the FCF projection period (horizon period). * Discount rate – The rate used to discount projected FCFs and terminal value to their present values. DCF Methodology The DCF method of valuation involves projecting FCF over the horizon period, calculating...
Words: 617 - Pages: 3
...Capital Budgeting Net Present Value Theoretical Background The capital budgeting decision is basically based on a cost-to-benefit analysis (Chatfield & Dalbor, 2005). The cost of the project is the net investment and the benefits of the project are the net cash flows. Comparison of these constituents ultimately leads to project acceptance or rejection. As suggested by Bester (nd.), there are many advantages to using net present value as a capital budgeting evaluation technique. Some being as follows: * Incorporates the risk involved with a specific project. * Will depict the potential increase in firm value (i.e. the increase in shareholder wealth). * The time value of money is taken into account. * All expected cash flows are taken into account. * The method is relatively straightforward and simple to calculate. However this method does come with disadvantages. For example (Bester, nd.): * Outcomes are depicted in Rand values and not percentages, thus relative comparison may prove difficult. * NPV requires a predetermined discount rate (cost of capital) which may be difficult to calculate. “Academics have long promoted the use of NPV” (Correia & Cramer, 2008, pg 33). Net Present Value (NPV) is one of the most straight-forward and common valuation methods in capital budgeting. Stated simply, NPV can be defined as a “project’s net contribution to wealth” (Brealey, Myers & Allen, 2008, pg 998), and could also be observed as “an estimate...
Words: 1807 - Pages: 8
... From the financial analysis I recommend that Clark Paints pursue the option of producing their paint cans internally versus buying from a supplier. On a cursory review, the analysis indicates the annual cost to produce the cans is $422,460 versus buying at a price of $495,000. This is a before tax savings of $72,540 ($58,351 after taxes) annually by producing the paint cans versus purchasing from a supplier. The payback on the equipment investment is realized in 3.43 years making the equipment paid for prior to the five year depreciation schedule. This indicates that the investment cost for the equipment is financially sound. To truly understand if the decision is financially correct, I will use the Net Present Value (NPV) and Internal Rate of Return (IRR) to justify the decision. NPV is a time series of cash flows for both incoming and outgoing (Garrison, 2010). Since the NPV is $33,040, we can assume that the project will recover the original cost of the equipment investment and generate excess cash flow justifying the original allocation of funds to purchase. Clark Paints - Net Present Value Before Tax After tax % PV Present Item Year Amount Tax% Amount Factor Value Cost of machine 0 $ (200,000) $ (200,000) 1 $ (200,000) Annual cash savings 1-5 $ 72,540 65% $ 47,151 3.60 $ 169,969 Tax savings due to depreciation 1-5 $ 32,000 35% $ 11,200 3.60 $ 40,374 Disposal value 5 $ 40,000 $ 40,000 0.57 $ 22,697 Net Present Value $ 33,040 The...
Words: 447 - Pages: 2
...AGENDA: CAPITAL BUDGETING DECISIONS A. Present value concepts. 1. Interest calculations. 2. Present value tables. B. Net present value method. C. Internal rate of return method. D. Cost of capital as a screening tool. E. Further aspects of the net present value method. 1. Total-cost approach. 2. Incremental-cost approach. 3. Least-cost decisions. F. Uncertain future cash flows. G. Preference rankings. H. Payback period method. I. Simple rate of return method. J. (Appendix 14C) Income taxes in capital budgeting PRESENT VALUE CONCEPTS A dollar today is worth more than a dollar a year from now because a dollar received today can be invested, yielding more than a dollar a year from now. MATHEMATICS OF INTEREST If P dollars are invested today at the annual interest rate r, then in n years you would have Fn dollars computed as follows: Fn = P(1 + r)n EXAMPLE: If $100 is invested today at 8% interest, how much will the investment be worth in two years? F2 = $100(1 + 0.08)2 F2 = $116.64 The $100 investment earns $16.64 in interest over the two years as follows: |Original deposit |$100.00 | |Interest—first year ($100 × 0.08) | 8.00 | |Total |108.00 | |Interest—second...
Words: 3769 - Pages: 16
...Weighted Average Cost of Capital Capital Structure Debt Equity Preferred Total Cost Weight Total Cost 6.20% 40.00% 2.48% 12.40% 50.00% 6.20% 8.00% 10.00% 0.80% 100.00% 9.48% The weighted average cost of capital represents the rate of return that a company must repay its creditors for using their fun while the net present value of a project uses the time value of money to analyze the profitability of a capital investment. The NPV is calculated by discounting future cash flows to what their value is today and then using the total amount of discou future cash flows to calculate the net present value of the total investment. The cost of capital is used in NPV analysis because the calculations to determine the net present value are based on the cost The internal rate of return is the rate at which the present value of all future cash flow is equal to the initial investment. In ot The cost of capital is used in IRR analysis because the way in which the IRR relates to the cost of capital determines whether o If the IRR is greater than the cost of capital, then the project should be accepted If IRR is less than the cost of capital, the project should be rejected. reditors for using their funds. a capital investment. he total amount of discounted lue are based on the cost of capital. he initial investment. In other words, it is the rate at which an investment breaks even. pital determines whether or not a project should be accepted....
Words: 269 - Pages: 2
...Methodology The method used to analyse this case was to determine a value for Netscape Communications Corporation as a company. The net present value (NPV) method was used to estimate the firm's value in two parts. First, pro forma statements were used to estimate future yearly cash flows and then these cash flows were discounted to the present day. Second, a terminal value for Netscape was estimated using a terminal growth rate and discounted to the present. The total NPV was the sum of these present values. If the total present value of the company is around $1 billion, then this amount would support a new issue price of $28 per share. Data Requirements Primary data requirements for this analysis were consolidated income statements and balance sheets for Netscape for 1994 and 1995, comparative information on potential competitors, historical data of the IPO market and information on Internet-related IPOs. Additional data was used through key assumptions made to develop the pro forma cash flow analysis. Assumptions The key assumptions used in this case are listed in Table 1 and they are based on similar data and experiences for Microsoft. Table 1 Key assumptions used for Netscape IPO analysis. Assumption Value Total cost of revenues (% of total revenues) 10.4% R&D (% of total revenues) 36.8% Other operating expenses (% of revenues) Decline on straight-line basis from 80.9% of total revenues in 1995 to 20.9% in 2001 Capital...
Words: 437 - Pages: 2
...Acquisition of American Chemical Company Executive Summary August 2012 Statement of the Problem: American Chemical Corporation is selling its sodium chlorate plant located near Collinsville, Alabama. This provides Dixon Corporation with an opportunity to purchase the plants net assets for the asking price of $12 million. The following analysis is to determine whether or not Dixon should purchase Collinsville plant with debt capital or invest in building a new one. The acquisition is pending approval from Dixon’s Board of Directors. Discussion: Strategy Analysis The purchase of the Collinsville plant offers Dixon an opportunity to grow its market share in the paper and pulp industry. Adding sodium chlorate to its product portfolio will expand its product line and reach in the paper and pulp industry. Dixon and the Collinsville plant have some of the same major customers, which will enable Dixon to market the sodium chlorate through its existing sales team. The Collinsville plant is strategically located in Southeastern U.S., the heart of the paper and pulp industry. This location complements Dixon’s primary facility located in Georgia and creates a localized hub for its sales team. Purchasing the Collinsville plant, provides the following benefits over building a new plant: 1) The Collinsville plant provides the ability to start generating revenue immediately, versus in one to two years. 2) Collinsville’s existing customer base is a benefit since it is harder to acquire...
Words: 1417 - Pages: 6
...relatively extended period of time in the future. 2. Cost of capital is the weighted minimum desired average rate that a company must pay for long-term capital while discounted rate of return is the maximum rate of interest that could be paid for the capital employed over the life of an investment without loss on the project. 3. The basic principles in capital budgeting are: 1. Capital investment models are focused on the future cash inflows and outflows - rather than on net income. 2. Investment proposals should be evaluated according to their differential effects on the company’s cash flows as a whole. 3. Financing costs associated with the project are excluded in the analysis of incremental cash flows in order to avoid the “double-counting” of the cost of money. 4. The concept of the time value of money recognizes that a peso of present return is worth more than a peso of future return. 5. Choose the investments that will maximize the total net present value of the projects subject to the capital availability constraint. 4. The major classifications as to purpose are: 1. Replacement projects - those involving replacements of worn-out assets to avoid disruption of normal operations, or to improve efficiency. 2. Product or process improvement - projects that aim to produce additional revenue or to realize cost savings. 3. Expansion - projects that enhance long-term returns due to increased...
Words: 1192 - Pages: 5
...CHAPTER ONE Introduction Understanding and being able to use capital budgeting techniques and investment appraisal tools is usually a standard requirement for most business degrees. In addition learning such methods will also give one an advantage in a real business situation, in which there is the consideration of significant capital expenditure project. Capital budgeting assists management decisions making on the process of ensuring growth of the organization. The techniques are divided into two types: one, Traditional (non-discounting) that includes pay back method, accounting rate of return (ARR). Two, discounting cash flow that includes net present value (NPV), internal rate of return (IRR) Profitability Index (PI). Before an investment appraisal is conducted, there are a number of points to keep in mind. Whilst the tool presented will give an evaluation of the worth of a project, one should consider that the answer is only a guide. In short, the results of an investment appraisal should be considered in conjunction with both common sense and other qualitative factors such as a business’s overall strategy. Secondly, before an investment appraisal is conducted, one should consider whether or not the project is mutually exclusive. Where a project is mutually exclusive, then only the best project should be selected. Where on the other hand, projects are independent; one may select all projects which give the appropriate return. 1.1 Background of the study Corporate finance...
Words: 7901 - Pages: 32
...of potential options based on several factors such as payback periods, internal rate of return, and the net present value for each project. Each factor should work together effectively to ensure the greatest return in the least amount of time. This paper will focus on determining the best financial outcome for a capital budget using these methods and calculations. To gain an understanding of the capital budget process, Project A and B will be analyzed to determine which project is best for a city council. The calculations will also help to justify each project and if both can be used simultaneously. 2 CRUNCHING NUMBERS Payback Period (Project A and B) The period for payback is the technique which is used measure the length of time that a project recoups the initial investment of the firm. Following the technique, the profits before depreciation (cash flow) is the amount of time required to repay an investment, while accumulating investment returns (Morrell, 2007). The shorter payback period is preferred because the investment costs are paid earlier allowing available funds for future use, in addition to less risk factor. According to Mikesell (2010) the shorter the payback period, the more attractive the project will appear to the firm (Fiscal Administration, 2010 custom edition). The formula used to conduct a payback period analysis is Years + (Remaining Payback/Net Paid). To calculate the payback period it is essential...
Words: 1724 - Pages: 7
