Cullumber Inc. owns and operates a number of hardware stores in the Atlantic region. Recently, the company decided to open anothe store in a rapidly growing area of Nova Scotia. The company is trying to decide whether to purchase or lease the building and related facilities. Currently, the cost of funds for Cullumber is 10%. Purchase: The company can purchase the site, construct the building, and purchase all store fixtures. The cost would be $1,840,000. An immediate down payment of $405,000 is required, and the remaining $1,435,000 would be paid off over five years with payments of $347,000 per year (including interest payments made at the end of the year). The property is expected to have a useful life of 12 years, and then it will be sold for $590,000. As the owner of the property, the company will pay $51,000 in occupancy expenses at the end of each year. Lease: First National Bank has agreed to purchase the site, construct the building, and install the appropriate fixtures for Cullumber if Cullumber will lease the completed facility for 12 years. The annual payments would be $310,000. Cullumber would have no responsibility related to the facility over the 12 years. The terms of the lease are that Cullumber would be required to make 12 annual payments. (The first payment is to be made at the time the store opens and then one each following year.) In addition, a deposit of $100,000 is required when the store is opened. This deposit will be returned at the end of the twelfth year, assuming there is no unusual damage to the building structure or fixtures. Assume a 10% discount rate.
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.
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