...Difficulties of the NPV-method The Net Present Value (NPV) is a method to compare the value of an investment now and that amount in the future, taking into account the cost of capital and the cash flows generated by the investment. The formula to calculate the NPV is as follows: With t as the time of cashflow, i the discount rate and R the net cashflows. Although the formula to calculate the NPV is straightforward and takes into account the value of a cashflow (money) over time, there still is a lot of information that is up to discussion, to which numbers to use. The short comic below gives an idea: One of the umbers that is most easy to calculate is the investment, which is not more than a number. However, from that moment on all are just assumptions. An assumption of the future cash flows that will be generated and the discount rate of cost of capital. Let me use the example of the initial public offering of Twitter, for which the Financial Times has made a simplistic tool to calculate the market value of the company (http://www.ft.com/intl/cms/s/2/8ae5045c-4159-11e3-b064-00144feabdc0.html#axzz2lynPs27Z). Now, this short analysis does not have the goal to critique the tool, I merely use it to show what a different cost of capital can do with the ‘’market value of the company’’. A cost of capital of 10% will give an enterprise value of 23.1 billion dollar, while a cost of capital of 12% will give an enterprise value of 15.4 billion dollar. A discounted cash...
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...market value of $32,600. What is the difference between these two values called? A. net present value B. internal return C. payback value D. profitability index E. discounted payback The length of time a firm must wait to recoup the money it has invested in a project is called the: A. internal return period. B. payback period. C. profitability period. D. discounted cash period. E. valuation period. The internal rate of return is defined as the: A. maximum rate of return a firm expects to earn on a project. B. rate of return a project will generate if the project in financed solely with internal funds. C. discount rate that equates the net cash inflows of a project to zero. D. discount rate which causes the net present value of a project to equal zero. E. discount rate that causes the profitability index for a project to equal zero. Rossiter Restaurants is analyzing a project that requires $180,000 of fixed assets. When the project ends, those assets are expected to have an aftertax salvage value of $45,000. How is the $45,000 salvage value handled when computing the net present value of the project? A. reduction in the cash outflow at time zero B. cash inflow in the final year of the project C. cash inflow for the year following the final year of the project D. cash inflow prorated over the life of the project E. not included in the net present value The internal rate of return is: A. the discount rate that makes the net present value of a...
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...In finance, the net present value (NPV) or net present worth (NPW)[1] of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows of the same entity. In the case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the NPV is simply the PV of future cash flows minus the purchase price (which is its own PV). NPV is a central tool in discounted cash flow (DCF) analysis and is a standard method for using the time value of money to appraise long-term projects. Used for capital budgeting and widely used throughout economics, finance, and accounting, it measures the excess or shortfall of cash flows, in present value terms, once financing charges are met. NPV can be described as the “difference amount” between the sums of discounted: cash inflows and cash outflows. It compares the present value of money today to the present value of money in future, taking inflation and returns into account The NPV of a sequence of cash flows takes as input the cash flows and a discount rate or discount curve and outputs a price; the converse process in DCF analysis — taking a sequence of cash flows and a price as input and inferring as output a discount rate (the discount rate which would yield the given price as NPV) — is called the yield and is more widely used in bond...
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...You have been asked to support analysis of acquisition decisions involving net present value analysis. 1. You are analyzing the net present value of a project over a 16 year period. Based on the rates in the textbook, what is the actual discount rate you would use given that your analysis must consider the effects of inflation/deflation? In analyzing the pet present value of a project over a 16 year period, the inflation rate must be included in the computation of the discount rate to be used. This means that the nominal rate be adjusted for the inflation rate to arrive at the real interest rate which is then used as the discount rate. 2. What is the present value of $25,000 that you will receive at the end of two years? Given that there was no information provided for the discount rate, I assumed a discount rate of 10%, hence Present value of $25,000 to be received 2 years from now = $25,000/[(1+10%)^2] = $20,661.16 3. What is the present value of $2,000 a month over the next 3 years? 4. What is the net present value of a lease that requires you to pay $10,000 at the beginning of each year for the next five years and includes a provision for a rebate of $5,000 at eh end of Year 5? 5. What is the net present value of an item that has a purchase price of $20,000, requires $1,000 maintenance at the end of each year except year 4, and is expected to have a salvage valueof $1,000 at the end of the 5 year useful...
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...Net Present Value and Decision Making: From the following information on a project, calculate its net present value (NPV) after its 4-year useful life and state whether it is an acceptable project. Assume a required rate of return of 10% pa: |End of year |0 |1 |2 |3 |4 |5 | |Capital outlay |–30,000 |–15,000 | | | | | |Cash inflows | | 15,000 |25,000 |20,000 |16,000 | | |(operating) | | | | | | | |Cash outflows | |-7,000 |-8,000 |-9,000 |-11,000 | | |(operating) | | | | | | | |Scrap | | | | | |6 000 | Solution: |End of year |0 |1 |2 |3 |4 |5 | |Capital outlay |-30,000 ...
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...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 to want to invest in a project that does not create a positive return therefore knowledge of what the project is worth in the present holds great importance...
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...Net present Value, Mergers and acquisitions FIN501 - Strategic Corporate Finance Net present Value, Mergers and acquisitions To start I would like to explain the difference and meaning of the present value of the future cash flows from an investment and the amount of investment. Present value of the expected cash flows is computed by discounting them at the required rate of return. For example, an investment of $1,000 today at 10 percent will yield $1,100 at the end of the year; therefore, the present value of $1,100 at the desired rate of return (10 percent) is $1,000. The amount of investment ($1,000 in this example) is deducted from this figure to arrive at net present value which here is zero ($1,000-$1,000). A zero net present value means the project repays original investment plus the required rate of return. A positive net present value means a better return, and a negative net present value means a worse return, than the return from zero net present value. It is one of the two discounted cash flow techniques (the other is internal rate of return) used in comparative appraisal of investment proposals where the flow of income varies over time (BusinessDictionary.com, 2013). Part I: Given that Google's cost of capital (discount rate) is 11%, below is the projected net present value using the following data which was provided; Year Cash Flow, (0) -$2,425,000, (1) 450,000, (2) 639,000, (3) 700,000, (4) 550,000, (5) 1,850,000. To calculate present value (PV)...
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...Foundations of the Net Present Value Rule Figure 2-1 illustrates the problem of choosing between spending today and spending in the future. Assume that you have a cash inflow of B today and F in a year's time. Unless you have some way of storing or anticipating income, you will be compelled to consume it as it arrives. This could be inconvenient or worse. If the bulk of your cash flow is received next year, the result could be hunger now and gluttony later. This is where the capital market comes in. It allows the transfer of wealth across time, so that you can eat moderately both this year and next. The capital market is simply a market where people trade between dollars today and dollars in the future. The downward-sloping line in Figure 2-1 represents the rate of exchange in the capital market between today's dollars and next year's dollars; its slope is 1 + r, where r denotes the 1-year rate of interest. By lending all your present cash flow, you could increase your future consumption by (1 + r)B or FH. Alternatively, by borrowing against your future cash flow, you could increase your present consumption by F/(1 + r) or BD. Let us put some numbers into our example. Suppose that your prospects are as follows: |Cash on Hand: |B = $20,000 | |Cash to be received 1 year from now |F = $25,000 | If you do not want to consume anything today, you can invest $20,000 in the capital market at, say, 7 percent. The rate...
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...Question 1 Net present value computation is a financial budgeting technique used to enable assessment of proposed investments. It is alternatively referred to as the discounted cash flow technique. Specifically, it refers to the difference between the present value cash outflows and that of cash inflows that would result from making a given investment. This investment could be an expansion or purchase of a new plant, purchase of new machinery and addition of assets. In order to accept or reject a proposed investment, its net present value (NPV) is taken into consideration (Jackson, Sawyers & Jenkins, 2013). When computed, NPV obtained is usually a positive value, zero or a negative value. Positive NPV is whereby the present value of cash...
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...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. ...
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...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...
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...In addition, Guillermo has a patented process that creates a flame-retardant for his furniture coating but he will need to buy a separate product for a finish coating. Capital Budget Evaluation Techniques Guillermo has many evaluation techniques to choose from to make his capital investment decision. He can also combine more than one technique. The following is a description of the techniques he might use. Finding the Net Present Value (NPV) is one evaluation technique. Net Present Value is a comparison of the present value of the future cash inflows to the cost of projectors by subtracting the cost of the investment from the present value of the future cash inflows (Edmonds, et. al., 2007). “A positive net present value indicates the investment will yield a rate of return higher than 12 percent. A negative net present value means the return is less than 12 percent” (Edmonds, et. al., 2007). If the rate of return is higher than the desired rate of return (and more than 12 percent) Guillermo should accept the proposal. The net present value evaluation technique will assist in deciding if purchasing the new machines and robotics will be a good investment. Each proposal can be evaluated in the same manner. The one that produces the highest rate of return should be the proposal...
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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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...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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...Instructor Nickey Turner Walden University Running head: Portfolio Project-Capital Budgeting Page 2 INTRODUCTION Capital Budgeting is defined as the process of planning and managing a firm’s long-term investments (Ross, Westerfield & Jordan. 2013). The question of what long term investment should be made is the first step of answering this question. The issues that arise with the asking of this question will be detailed in this paper. Capital Budgeting techniques include the Payback Rule, IRR, NPV, and the Profitability Index. PAYBACK RULE The payback method indicates that an investment is acceptable if its calculated payback is less than some prescribed number of years. The payback method does not consider the present value of cash flows. Under this method, an investment project is accepted or rejected on the basis of payback period. Payback period means the period of time that a project requires to recover the money invested in it (www.accountingformanagement.org).The payback period of a project is expressed in years and is computed using the following formula: Formula of payback period: According to this method, the project that promises a quick recovery of initial investment is considered desirable. If the payback period of a project computed by the above formula is shorter than or equal to the management’s maximum desired payback period, the project is accepted otherwise it is rejected. For example, if a company wants to recoup the cost of a machine...
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