Explore BrainMass

Explore BrainMass

    Net Present Value (NPV)

    Net Present Value (NPV) analysis is the most important tool for financial managers when making capital budgeting decisions. The ultimate goal of a financial manager is to make decisions that increase the value of the firm to shareholders. Imagine a project that costs $10,000 and makes a company $9,000; the project will lose $1,000, and it should be rejected. What if the same project immediately brings in $11,000? Accepting this project will increase the value of the firm. It is clear in these examples what type of projects should be accepted and what projects should be rejected. 

    However, what happens when a project costs $10,000 today, and provides $10,000 next year? We know because of the concept of time value of money you wouldn't invest $10,000 today to only receive $10,000 in the future. What if the project will bring in $10,500 next year? At what point does it make financial sense to accept the project?

    A net present value analysis takes into account all of the cash flows associated with a project, both cash inflows and cash outflows. These cash flows are discounted using a required rate of return determined by the company as appropriate for the project. The discounted cash flows are added together to get a "net present value," that is, the sum of both the positive and negative cash flows discounted to present value. 

    We use the present value formula to discount the cash inflows and outflows of the project. 

    Where, r = the discount rate
                n = the time period that the cash flow occurs

    For a typical project, there is a cash outflow in the first period when the project is undertaken. Once the project is completed, the project will generate cash flows over its useful life. This suggests that the NPV of a typical project will look something like the following formula - we first subtract the initial investment, then add back the subsequent discounted cash inflows.

    Where C0 = the initial cash investment (cash outflow)
               C1 = the cash flow from the first period
               Cn = the cash flow from the nth period
                 n = the last period in the life of the project
                 r = the interest rate

    Let's look at our $10,000 example. Imagine that $10,000 is an investment in a new oven. The oven is going to make 1000 additional loafs of bread than its predecessor each year, which can each be sold for a profit of $2. There are no additional costs for running this oven, in fact, the new oven will save the company $500 dollars a year. The useful life of the oven is five years, with no salvage value. What is the net present value of the oven?

    Each year the oven generates cash flows for the company of $2,500 ((1000 loafs x $2) + $500). We can look at the cash flows as follows, and discount them back to the present period using the present value formula (using a 5% discount rate for the oven). As we can see below, the net present value is positive; therefore, we should buy the oven. 

    Net Present Value = Sum of All Discounted Cash Flows = -10,000 + 1,959 + 2,057 + 2,160 + 2,267 + 2,381 = $823

    Photo by Michelle Spollen on Unsplash

    © BrainMass Inc. brainmass.com April 19, 2024, 4:40 am ad1c9bdddf

    BrainMass Solutions Available for Instant Download

    Calculating Net Present Value Using Inflation-Adjusted Discount Rate

    Bing Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $281,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating revenues from the facility are expected to be $116,000, in nominal term

    Straight Line Dep-: Net Present Value & Internal Rate of Return

    Straight-line: A new project will require an equipment worth $100,000. The installation expenses are $10,000. The project will run for five years. The depreciation is straight-line basis. The equipment will be depreciated to a zero book value at the end of the project. The project will require an initial investment in net workin

    MACRS Depreciation: Net Present Value & Internal Rate of Return

    MACRS: The equipment cost is $50,000 and it would cost another $10,000 to modify it. Assume that the equipment falls into the MACRS 3-year class. The equipment will be sold after 3 years for $20,000. It would require an increase in net working capital of $2,000 at the start of the project. This working capital would be recovered

    Evaluating the cost and benefit for a capital budgeting decision

    Capital Budgeting Sky View Resorts, Inc. (SVR) SVR owns and operates a resort lodge in Western Maryland. The BOD is considering the replacement of the seven years old HVAC system with a newer and more energy efficient system. The decision has been accelerated since the US Congress has approved tax incentives for business

    Net cash flows, NPV, IRR, MIRR, Payback and Discounted Payback

    You are evaluating a proposal to buy a new machine. The base price is $108,000, and shipping and installation costs would add another $12,500. The machine is depreciated using straight line method, and it would be sold after 3 years for $60,000. The machine would require a $5,500 increase in net operating working capital. There

    Calculating Net Present Value (NPV) from cash flows

    You are the finance manger of ABC Co. The Chief Executive is desirous of investing in a new venture. Preliminary findings and investigations have indicated that the venture might enhance the social corporate responsibility of the organization by creating employment. However, whether the project would be profitable or not has

    Nominal & Discounted Payback, Net Present Value, IRR

    See the attachment for tables. 1. A company has $300,000 in a bank account established for Capital Investments. This account pays 4% interest, compounded annually. A member of the finance department has approached you with an investment opportunity for the $300,000 that covers a five-year period and has the following projecte

    Purchase Decision Based on Net Present Value: Air Conditioners

    Net Present Value is a concept which confuses many students, mostly because they are unfamiliar with its application. You would actually be surprised how many potential decisions can benefit from considering the impact of NPV. For example, should you buy a car and get $2,000 cash or a 5 year no interest loan - which is really

    Project Evaluation Using Net Present Value and Payback Period

    Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2.55 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life. The project is estimated to generate $2,030,000 in annual sales, with costs of $725,000. The tax r

    Economic Value Added and NPV and IRR

    Explain Economic Value Added and compare it with NPV and IRR methods of capital budgeting in terms of capital budgeting project evaluation methods.

    Project Evaluation Problems

    UNIT 3: TEXTBOOK PROBLEMS CHAPTER 7: PROBLEM 1b Project A Project B Discount Rate 15% 15% Year 0 ($14,500) ($9,800) Year 1 $8,500 $4,700 Year 2 $6,800 $4,200 Year 3 $2,800 $4,100 NPV = #NAME? #NAME? (Note: You will choose the project that has the highest NPV since i

    Capital Goods Manufacturers Efficient Machines

    Complete the following on pg. 224 #12 (under questions section), pg. 225 #1, 2 (under problems section) #12 For each of the following companies, access the sustainability of its competitive advantage. a. Analog Devices, which develops specialized applications for analog semiconductors, has invested countercyclically to cash

    Capital Structure Article

    Choose an article on capital structure. Submit a summary of the article along with your reaction to the article. The summary should be a minimum of 1 page and your reaction should also be a minimum of 1 page.

    Considerations for Investments

    139 #1, 5 (under questions sections), pg. 140 #2, 3 (under problems section) 1#. Comment on the following statements: a. "Because our new expansion project has the same systematic risk as the firm as a whole, we need do no further risk analysis on the project." b. "Our company should accept the new potash mine project at

    Evaluating Capital Budgeting Decisions

    Carroll Tree Ranch is considering expanding an existing plant on a piece of land it already owns. The land was purchased 15 years ago for $162,500 and its current market appraisal is $410,000. A capital budgeting analysis shows that the plant expansion has a net present value of $65,000. The expansion will cost $865,000, and

    Do we need CAPM for capital budgeting?

    Read the article "Do we need CAPM for capital budgeting?" Do you agree or disagree with the authors' position? Why or why not? Discuss the characterization of Jagannathan and Meler's assumptions. Are they valid?

    Depreciation and Net Present Value Problems

    1. You are thinking of opening an internet coffee shop and estimate the following cash flows. The cost of the establishment is $320,000 for the building and $185,000 for equipment (tax life of 5 years) and both are placed it into service on January 1. The business will earn $18,000 per week in revenue and have cash expenses of $

    Capital Budgeting for a golf course

    Describe the capital budgeting process used in the organization you work for today. Provide a general indication of who is involved in the process; how the process flows; what assets are most often involved; and what decision methods (NPV, Payback; IRR, etc) are used. The public sector (government) handles capital budgeting in

    Analysis of Profitability & Capital Budgeting: Hersheys 2008 Operating Budget

    Part I The objective of Part I is for the student to become familiar with the cost-volume-profit analysis as a tool used for decision making. Review the "Consolidated Statements of Income" In Hershey's 2007 annual report (ignore all figures below net income, such as, per share information). Using the spreadsheet below fill in

    Genesis Energy- WACC, NPV, payback, and IRR

    Following the example of the operations management team, do the following: Download the Capital Budgeting spreadsheet, and compute the WACC for Genesis Energy. Using the information provided in the spreadsheet, analyze Genesis Energy's project options. Then, calculate the periodic and cumulative net cash flows for ea

    Excel Model for Capital Budgeting

    Chapter 11-P18: Doing the Scenario Analysis "Manually" Hi All: I want to explain an alternative method (and I think better, for learning at least) of solving the scenario analysis than working with built-in Excel tables. Working with datatables is really an advanced feature in Excel. It's fine to this part "manually.

    Aggressive Working Capital Policy

    An aggressive working capital policy, may increase the entity's return, but it also increases the risk. 1. Please solve this Net Income Problem. A firm has the following accounts: Net patient revenue = $1,500,000 Supply expense = $200,000 Depreciation expense = $100,000 Salaries and benefits = $700,000 Other e

    Alternative Capital Budgeting Techniques

    Futronics Inc. is a $2 billion firm that sells communications services. Founded in 1937, Futronics has provided consumer products, as well as government systems and services, for well over half a century. Due to a sharp increase in competition, flattened sales, and external economic conditions, Futronics is implementing a corpor

    Time Value of Money Article

    Find a web article related to time value of money. Post a link to the article and respond to the article, discussing why you find it especially interesting. Also, and critically, how would you improve the analysis?

    Capital Budgeting and Cash Flows

    Why is capital budgeting such an important process? Why are capital budgeting errors so costly? Differentiate between NPV, PI, and IRR methods. What are the advantages and disadvantages of using each of these methods? Why is there a focus on cash flows rather than accounting profits in making capital-budgeting decisions? Why suc

    Computing Net Income Different Ways

    1. Assume that a Medical Center, a for-profit hospital, has $8 million in taxable income for 2014 and its tax rate is 28%. a. Given this information, what is the firm's net income? b. Suppose the hospital pays out $750 thousand in dividends. A stockholder receives $17 thousand. If the stockholder's tax rate on dividends is 2

    Computing and Explaining Net Present Value and Internal Rate of Return

    ABC Corporation is considering an expansion project. To date they have spent $150,000 investigating the viability of the project and have decided to proceed. The proposed project will cost $1,500,000 in addition to the $150,000 that was spent on the feasibility study. The project will be depreciated over a 3 year MACRS class li

    Calculating the NPV in the given case

    A project has annual cashflows of $10,500 for the next three years and then $20,000 each year for the following 12 years. The IRR for this project is 11%. It's WACC is 9%. What is the project NPV? (The IRR enables you to calculate the initial investment, because it's the discount rate at which the NPV of a project is equal to 0.