Partial plc is considering what projects to undertake with the limited capital it has for investment. The possible projects, none of which could be delayed, are as follows: Project Investment needed (£000) NPV (£000) T 1,000 + 300 U 6,600 + 1,200 V 4,000 + 800 W 3,000 - 300 X 2,500 + 600 Y 7,000 + 1,050 Z 5,000 +800 All the projects are divisible, allowing a fraction to be undertaken but none can be undertaken more than once. In addition, projects V and Z cannot both be undertaken as they would use the same building and machinery. The capital available for investment is £7 million. The chief executive has suggested raising another £3 million by taking out a further bank loans so that more of the projects can be undertaken. QUESTIONS: (a) Calculate the maximum NPV that could be achieved with the £7 million available and state the combination of projects that would achieve this. (b) Calculate the increase in NPV that could be achieved if the company took out the bank loan, as suggested by the chief executive. (c) What would be the NPV achieved with the original £7 million if it was decided that all projects were now indivisible.
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.
Partial plc is considering what projects to undertake with the limited capital it has for investment. The possible projects, none of which could be delayed, are as follows:
| Project | Investment needed (£000) | |
| T | 1,000 | + 300 |
| U | 6,600 | + 1,200 |
| V | 4,000 | + 800 |
| W | 3,000 | - 300 |
| X | 2,500 | + 600 |
| Y | 7,000 | + 1,050 |
| Z | 5,000 | +800 |
All the projects are divisible, allowing a fraction to be undertaken but none can be undertaken more than once. In addition, projects V and Z cannot both be undertaken as they would use the same building and machinery.
The capital available for investment is £7 million. The chief executive has suggested raising another £3 million by taking out a further bank loans so that more of the projects can be undertaken.
QUESTIONS:
(a) Calculate the maximum NPV that could be achieved with the £7 million available and state the combination of projects that would achieve this.
(b) Calculate the increase in NPV that could be achieved if the company took out the bank loan, as suggested by the chief executive.
(c) What would be the NPV achieved with the original £7 million if it was decided that all projects were now indivisible.
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