Problem: The CFO of Casio Industries is considering the launch of a new fuel cell powered calculator to its existing line of college supplies. The horizon of the project has been estimated to be 10 years. The machine that will manufacture the calculators costs $3 million, and will be depreciated using the straight line method to zero book value over 15 years. Projected sales are $500,000 in year 1, $550,000 in year 2, $600,000 in year 3, and so on ($50,000 increase until year 10). Annual costs are estimated to be 20% of the current year sales. The CFO believes that the machine can be sold at the end of the project for $600,000. Working capital requirements are estimated to be 5% of the following year sales (so NWC at time 0 is 5% of sales at time 1, and so forth). If the project is taken, it will use an existing office space for which the company paid $550,000 three years ago, and that can be rented today for $40,000 a year, to be paid at the end of each year. The tax rate is 40%. Questions: a) Forecast the project (unlevered) cash flows that you should discount. b) What is the NPV of the project if the cost of capital (discount rate) is 10%?
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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