Bruno's Lunch Counter is expanding and expects operating cash flows of $27,900 a year for 4 years as a result. This expansion requires $66,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires $4,200 of net working capital throughout the life of the project. What is the net present value of this expansion project at a required rate of return of 10 percent? Multiple Choice O O O O $27,493 $22,439 $26,046 $21,108 $24,309
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Net Present Value (NPV) is a financial metric used to evaluate the profitability of an investment or a project. It represents the difference between the present value of cash inflows and the present value of cash outflows, taking into account the time value of money.
The NPV formula is calculated as follows:
NPV = (Cash Inflows / (1 + discount rate)^n) - Initial Investment Cost
where:
- Cash Inflows: The future cash inflows generated by the investment or project.
- Discount rate: The rate used to discount future cash flows to present values.
- n: The number of periods over which the cash inflows are generated.
A positive NPV indicates that the investment is expected to generate more cash flows than the initial investment cost, making it a profitable investment. On the other hand, a negative NPV indicates that the investment is expected to generate less cash flows than the initial investment cost, making it an unprofitable investment.
NPV is a useful tool for comparing different investment opportunities and determining the best use of limited capital. It considers the time value of money and takes into account the expected cash flows and the cost of capital, making it a more comprehensive measure of investment performance than simple measures such as return on investment.
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