...Net Present Value Net Present Value Formula Net Present Value (NPV) is a formula used to determine the present value of an investment by the discounted sum of all cash flows received from the project. The formula for the discounted sum of all cash flows can be rewritten as Net Present Value Alternative Formula When a company or investor takes on a project or investment, it is important to calculate an estimate of how profitable the project or investment will be. In the formula, the -C0 is the initial investment, which is a negative cash flow showing that money is going out as opposed to coming in. Considering that the money going out is subtracted from the discounted sum of cash flows coming in, the net present value would need to be positive in order to be considered a valuable investment. Example of Net Present Value To provide an example of Net Present Value, consider company Shoes for You 's who is determining whether they should invest in a new project. Shoes for you are will expect to invest $500,000 for the development of their new product. The company estimates that the first year cash flow will be $200,000; the second year cash flow will be $300,000, and the third year cash flow to be $200,000. The expected return of 10% is used as the discount rate. The following table provides each year's cash flow and the present value of each cash flow. Year Cash Flow Present Value 0 -$500,000 -$500,000 1 ...
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...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...
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...Capital Budgeting Christian Collor QRB/501 December 8, 2013 Mr. Rene Cintron CAPITAL BUDGETING There are many different methods business owners use to efficiently analyze business investment. One of these effective methods is the calculation of the net present value. The second most effective method would be the calculation of the internal rate of return. There are also other useful methods as well, for example, the payback rule and the profitability index. Many business owners use the above procedures to help them in their decision making of acquiring other businesses. The Net Present Value is important to a project because if the cost of the investment is going to be, or is more than the revenue from that project, then it may be more cost effective to shut down the project all together rather than lose more money. If multiple projects are available, then it is wise to first calculate the Net Present Value for each project, choose those that have a positive Net Present Value, and reject the ones that have zero or negative Net Present Values. Furthermore, the Internal Rate of Return method can be used, and generally, they should provide the same ranking of the projects because the projects with high Net Present Value also tend to have high Internal Rate of Return. There are many reasons the Internal Rate of Return is important to a company. If the rate of return is insufficient, it means additional cash is outflowing from the company than is inflowing...
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...Accounting for Business Decision Making Assignment Ali Nafiz S1409011055 Submitted on 9th November, 2014 Table of Contents Task 1 Task 2 Task 3 2-4 5-7 8-10 1 Ali Nafiz S1409011055 TASK 1 a) Anhad Sdn. Bhd. Budgeted statement of profit for the year ending 31 October 2014 RM (000s) Revenue (120000 × 8)1 Less Variable overheads Direct Materials (1200 × 2) × 95%2 Direct Labour (1200 × 1.32)3 Production overheads Selling overheads Distribution overheads Contribution Less Fixed overheads7 Indirect labour Production overheads Selling overheads Distribution overheads Administration overheads Budgeted Net profit 350 800 450 150 750 2500 1576 2280 1584 6004 6405 4206 5524 4076 RM (000s) 9600 1 2 Sales volume increase by 50%, which is equal to 800000 × 150% = 1200000. And the new selling price is RM 8. Material cost per unit is RM2, which remains unchanged, and 5% discount is given on the total. 5% discount would mean the budgeted cost for 2014 would be 95% of the cost of 2013. 3 Assuming that production of one unit takes 1 hour, for 800,000 units it takes 800,000 hours, which means labour 960,000 cost per hour is = 1.2, The new cost/hr for 2014 is 1.2 × 110% = 1.32. 800000 4 5 6 Production overheads increase in proportion with the 50% increase in sales volume; 480,000 280,000 400,000 800,000 × 1200,000 = 600,000 Variable selling overheads increase in line with the sales revenue; 7200,000 × 9600,000 = 640,000. Distribution overheads increase in...
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...Guillermo Case Study: Capital Budget Evaluation Techniques ACC/543 Guillermo Navalles faces many financial challenges in order to succeed in the present business environment. In order to ensure the continued profitability and competitive edge of Guillermo Furniture, he needs to make an investment decision on where to direct capital. He is deliberating between directing capital to purchase advanced equipment, or to adapt a brokerage business model. In order to assess the financial viability of both investment options, he is considering the application of capital budgeting techniques to help him in decision-making. Capital budget evaluation techniques can use data from financial and operating reports to predict potential performance of corporate investment; these entail evaluation using a suitable technique and giving recommendations based on calculations of forecasted future returns of investment. Capital evaluation strategies can be differentiated into techniques considering the time value of money, and techniques ignoring the time value of money. Guillermo will apply both techniques and rely on certain assumptions with their accompanying degree of added risk. The evaluation analysis assumptions are that the investment capital is $5 million with a desired return of 8 percent to cover inflation and decreased sales, as well as a 10-year investment term due to equipment life. The datasheet corrections are as follows: • The brokerage option requires no maintenance...
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...market, estimated value is £1m per year Opportunity 2 - Marketing and distribution of rage of genetically engineered vegetables seeds, which have already been developed by a biotechnology firm, with seeds from this firm and permit from this firm to market and distribute under a license agreement. This project would start in 2008 with a 5 years life time, until the seeds be superseded by newer generation of biotechnological developments. To carry out the projects, need IFG to have initial investment of £500K for fleet vehicles used for distribution purpose, and investment would be recapitalized at the end of fifth year with a value of 200K. Also, this projects would be enable IFG to utilize existing lying unused factory with office, with reduced annual rent of 200K (while in market, the rental value is £1m per year ) generated by this project. In the 5 years project lift time, total 29M sales income would be generated, and would not be subjected to any taxation because of the special status as a growth industry. As side effect of expanding product range of IFG with these new seeds, the firm would be able to attract a great deal of publicity which would improve the market position, and as an consequence, this would increase the profitability of IFG’s other product, with 100K for each of the five years. Financials study - Opportunity 1 IFG is a large firm and has a suitable factory with offices, currently lying unused. The open market rental value is £1m per annum (Assume...
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...Ocean Carriers’ Case Spring 2012 Ocean Carriers Ocean Carriers Inc. owned and operated capsized dry bulk carriers that carried iron ore worldwide. The company’s vessels were typically chartered on a “time charter” basis for a period of years. The charterer paid Oceans Carriers a daily hire rate for the entire length of the contract, determined what cargo the vessel carries, and controlled where 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...
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...vendor is offering a better deal prior to purchasing using payback, net present value, and internal rate of return method. Each piece has an estimated five-year life span with a desire payback period of three years at a 15% target rate. Model A Model B Cost, including installation $120,000 $110,000 Estimated annual labor savings $40,000 $32,000 Payback Methods Payback method calculates the amount of time it will take to regain the investment in a capital asset with no regard for the time cost of money (Baker & Baker, 2006). Payback Method Formula Investment /net annual = years payback period Model A payback period = $120,000 / $40,000 = 3 year payback period Model B payback period = $110,000 / $32,000 = 3.2 years payback period Net Present Value Net present value (NPV) used to evaluate and analyze the reliability of an investment and its profitability for capital budgeting purposes (Accounting for Management, 2011). The difference between the present value of cash inflows and the present value of cash outflows refers to net present value (Investopedia, 2011). NPV = Total PV of future cash flows – initial cash flow (CF0) n CFi NPV = Σ --------------------- - CFo i= 1 (1+r )^i r = discount rate n = time period of the project /investment An NPV greater than zero shows that the project adds value to the company, while the opposite which is lesser than zero will...
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...Week 5 Assignment ACC206 1. Basic present value calculations Future Value $12,000.00 Years: 5 Rate: 12% Present Value = $6,809 Annual Cash Flow $16,000.00 Duration 12 Rate 14% Present Value $90,565 Rate 10% Year Cash Flows Present Value 0 $ - $ - 1 $15,000.00 $13,636.36 2 $ - $ - 3 $10,000.00 $7,513.15 Present value $21,150 Rate 16% Year Cash Flows Present Value 0 $ - $ - 1 $8,000.00 $6,896.55 2 $8,000.00 $5,945.30 3 $8,000.00 $5,125.26 4 $10,000.00 $5,522.91 Present value $23,490 2. Cash flow calculations and net present value A. Year Cash Flow 20X1 ($10,000) 20X1 $1,300 20X2 $1,300 20X3 $14,550 B. 20X1 -10000 20X1 1120.69 20X2 966.1118 20X3 9321.569 1408.371 C. Yes it was a good idea to require the stock because the NPV is positive. 3. Straightforward net present value and internal rate of return NPV of Total Costs ($445,000.00) NPV of Total Savings $392,725.90 -$40,000 saved each year for 20 years. NPV of Cash Flows ($52,274.10) NPV is negative so it is not a good idea to acquire the landfill. 4. Straightforward net-present-value and payback computations Revenues 600000 Variable cost 400 400000 fixed cost 160000 40000 120000 Total cash...
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...Executive summary In this report, we will discuss about the capital budgeting of CapitaLand, one of the largest real estate companies in Asia. Business activities and financial background of CapitaLand will be mentioned in this report, also with the evaluation of two potential mutually exclusive capital investments as well as the objective of these investments for this company. This report also contents the analysis of four main different capital budgeting techniques used in the investments for supporting decision making process. Definition, formula of each technique will be given along with the figure of the investments as well as its advantages and disadvantages. The numeric data (initial investment, cash flows…) used for the calculating process will be disguised by our group. Recommendations and Suggestions will be given based on the analytic figure before having the final decision of which project will be chosen. 1. INTRODUCTION Capital Budgeting is the process of analyzing a company’s investible decisions in which the company determines if the projects are worth pursuing and will yield the most return over an applicable period of time. The investments can be purchasing new machinery, replacement machinery, new plants, new products, or research development projects. Select an effective and profitable investment is one of the most important of the financial management of an organization, moreover, having a suitable choice of investment helps the organization to...
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...three projects, the net present value, the internal rate of return, and the payback period will be evaluated in each case. It will also offer project selection recommendations for each scenario based on the net present value, as well as project selection recommendations based on the internal rate of return and the payback period. Project Evaluation The following three projects have been broken down and evaluated based on each of the provided scenarios. The net present value, payback period, and internal rate of return are included for each project. Project 1: | Cash Flows | Year 0 | $ (30,000) | Year 1 | $ 11,000 | Year 2 | $ 11,000 | Year 3 | $ 11,000 | Year 4 | $ 11,000 | Year 5 | $ 11,000 | Scenario 1 – using 5% NPV Rate – Calculations are as follows: -$30,000+ $11,000(1+0.05)1+ $11,000(1+0.05)2+ $11,000(1+0.05)3+ $11,000(1+0.05)4+ $11,000(1+0.05)5 = -$30,000 + $10,476.1905 + $9,977.3243 + $9,502.2136 + $9,049.7272 + $8,618.7878 = $17,624.24 NPV Payback period = 2.727 years IRR = 24.32% Scenario 2 – using 5.5% NPV Rate – Calculations are as follows: -$30,000+ $11,000(1+0.055)1+ $11,000(1+0.055)2+ $11,000(1+0.055)3+ $11,000(1+0.055)4+ $11,000(1+0.055)5 = -$30,000 + $10,426.5403 + $9,882.9766 + $9,367.7503 + $8,879.3842 + $8,416.4779 = $16,973.13 NPV Payback period = 2.727 years IRR = 24.32% Scenario 3 – using 6% NPV Rate – Calculations are as follows: ...
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...Chapter 10 CAPITAL BUDGETING AND RISK ANSWERS TO QUESTIONS: 1. The net present value model handles risk by discounting expected cash flows from a project by the firm's cost of capital. This discount rate is based upon the firm's average risk level. To the extent that a project has more than or less than average risk, the use of the firm's cost of capital will not make the appropriate risk adjustments. The basic model also does not explicitly consider the variability of a project's returns. 2. Risk, in the context of capital budgeting, is the possibility that actual returns from a project will differ from expected returns. It is often measured by the standard deviation of returns or the coefficient of variation of returns. 3. The standard deviation is an appropriate measure of risk when independent projects are being considered in a non-capital rationing situation. When two or more mutually exclusive projects are being evaluated and the projects are of different size, the coefficient of variation is a better measure. 4. The basic NPV model considers increasing risk over time by using a discount rate that is a compound rather than a simple rate. 5. The portfolio effect of a new project on the risk of a firm should be considered when the project is large and its returns are likely to be significantly less than perfectly correlated with returns of the remainder of the firm. Large mergers, especially of the conglomerate type, are one example...
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...shareholder's money. ROE is calculated as: ROE = Net Income/Shareholder's equity This net income is income after paying tax and preferred stock dividend but before paying common stock dividend.ROE measures profit generating efficiency of the company. (McClure, 2010) Higher the ROE, better the investment opportunity company is offering. Advantage of using ROE for investment decision is, it is easy to calculate and it tells how much profit company is generating for share holders. Ultimate goal of a company is to create value for shareholders. Thus, ROE is the right measure to find out if company is efficient in generating profit on its equity (and asset) or not. However, ROE is not the absolute indicator of investment value. If value of shareholder's equity falls, ROE will go up. Similarly, if company is taking large write-down, ROE will fall sharply. Share buyback also lowers ROE while there is no change in company's operation. (McClure, 2010) Internal Rate of Return (IRR) is an indicator of yield of an investment.IRR is widely used method in capital budgeting decisions. IRR is the discount rate where total present value of all cash inflows is equal to total present value of all cash outflows. i.e. IRR is the discount rate at which NPV is zero. Calculation of IRR is complex. To calculate IRR, NPV is equated to zero and r is determined. NPV = C0 + C1/(1+r) + C2/(1+r)^2 + …. + Cn/(1+r)^n When we make NPV = 0, value of r is the IRR Hit and trial method is used...
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...firm’s assets. • Net working capital equals current assets plus current liabilities. • Current liabilities are debts that must be repaid in 18 months or less. • Tangible assets are fixed assets such as patents. • Current assets are assets with short lives, such as inventory. 3. The owners of a limited liability company generally prefer: • being taxed personally on all business income. • having liability exposure similar to that of a general partner. • having liability exposure similar to that of a sole proprietor. • being taxed like a corporation. • being taxed like a corporation with liability like a partnership. 4. Which one of the following is least apt to help convince managers to work in the best interest of the stockholders?pay raises based on length of service • implementation of a stock option plan • threat of a proxy fight • management compensation tied to the market value of the firm’s stock • threat of a takeover of the firm by unsatisfied stockholders 5. a. Compute the future value of $2,000 compounded annually for 20 years at 4 percent. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Future value $_________ b. Compute the future value of $2,000 compounded annually for 15 years at 10 percent. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Future value $_________ c. Compute the future value of $2,000 compounded...
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...the present value of an investment?s future cash flows and its initial cost is the: • net present value. • internal rate of return. • payback period. • profitability index. • discounted payback period. 2. Which statement concerning the net present value (NPV) of an investment or a financing project is correct? • A financing project should be accepted if, and only if, the NPV is exactly equal to zero. • An investment project should be accepted only if the NPV is equal to the initial cash flow. • Any type of project should be accepted if the NPV is positive and rejected if it is negative. • Any type of project with greater total cash inflows than total cash outflows, should always be accepted. • An investment project that has positive cash flows for every time period after the initial investment should be accepted. Find the Week 1 Connect Problems answers here FIN 571 Week 1 Connect Problems 3. The primary reason that company projects with positive net present values are considered acceptable is that: • they create value for the owners of the firm. • the project's rate of return exceeds the rate of inflation. • they return the initial cash outlay within three years or less. • the required cash inflows exceed the actual cash inflows. • the investment's cost exceeds the present value of the cash inflows. 4. Accepting a positive net present value (NPV) project: • indicates the project will pay back within the required period of time. • means the present value of the...
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