Week 10 Discussion 1
From the scenario, suggest one (1) method in which Herb could use a cost-benefit analysis to argue for or against an expansion. Create three (3) optimal decision rules for Katrina’s Candies (e.g.., whether to hire more staff or hire temporary workers to meet production schedules).
The cost-benefit analysis that Herb could use to argue for or against an expansion would be the Net Present value method. Net Present Value (NPV) is the present value of net cash inflows generated by a project including salvage value, if any, less the initial investment on the project. It is one of the most reliable measures used in capital budgeting because it accounts for time value of money by using discounted cash inflows.
The Net Present Value relies on the concept of opportunity cost to place a value on cash inflows arising from capital investment. Opportunity cost is the calculation of what is scarified or foregone as a result of a particular decision. It is also referred to as the “real” cost of taking some action. It relies on the concept of opportunity cost to place a value on cash inflows arising from capital investment. Present value is the cash equivalent now of a sum receivable at a later date. If we didn’t spend that money and banked it instead, the opportunity cost includes both the initial sum and the interest earned.
The Net Present Value method is a technique where cash inflows expected in future years are discounted back to their present value. This is calculated by using a discount rate equivalent to the interest that would have been received on the sums, had the inflows been saved. A positive NPV means that the project is worthwhile because the cost of tying up capital is compensated for by the cash inflows that result.
The advantage of the Net Present Value method accounts for time value of money. Thus, it is more reliable than