Sunshine Smoothies Company (SSC) manufactures and distributes smoothies. It is considering the introduction of a "weight loss" smoothie. The project would require a $4 million investment outlay today (t = 0). The after-tax cash flows would depend on whether the weight loss smoothie is well received by consumers. There is a 30% chance that demand will be good, in which case the project will produce after-tax cash flows of $2 million at the end of each of the next 3 years. There is a 70% chance that demand will be poor, in which case the after-tax cash flows will be $1 million for 3 years. The project is riskier than the firm's other projects, so it has a WACC of 12%. The firm will know if the project is successful after receiving first year's cash flows. After receiving the first year's cash flows it will have the option to abandon the project. If the firm decides to abandon the project the company will not receive any cash flows after t = 1 , but it will be able to sell the assets related to the project for $3.5 million after taxes at t = 1.
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.
Sunshine Smoothies Company (SSC) manufactures and distributes smoothies.
It is considering the introduction of a "weight loss" smoothie.
The project would require a $4 million investment outlay today (t = 0).
The after-tax cash flows would depend on whether the weight loss smoothie is well received by consumers.
There is a 30% chance that demand will be good, in which case the project will produce after-tax cash flows of $2 million at the end of each of the next 3 years.
There is a 70% chance that demand will be poor, in which case the after-tax cash flows will be $1 million for 3 years.
The project is riskier than the firm's other projects, so it has a WACC of 12%.
The firm will know if the project is successful after receiving first year's cash flows.
After receiving the first year's cash flows it will have the option to abandon the project.
If the firm decides to abandon the project the company will not receive any cash flows after t = 1
, but it will be able to sell the assets related to the project for $3.5 million after taxes at t = 1.
Please review my concept of calculate the NPV of each possible options (4 options), considering
Remark : I use excel for calculation so the value of income in PV formula is negative value.
My understanding…
- Demand will be poor and abandon project after T1
=-4000000+70%*PV(12%,1,0,-1000000,0) +PV(12%,1,0,-3500000,0) - Demand will be poor and continue operating until T3
=-4000000+70%*PV(12%,1,0,-1000000,0)+PV(12%,2,0,-1000000,0)+PV(12%,3,0,-1000000,0) - Demand will be good and abandon project after T1
=-4000000+30%*PV(12%,1,0,-2000000,0)+PV(12%,1,0,-3500000,0) - Demand will be good and continue operating until T3
=-4000000+30%*PV(12%,1,0,-2000000,0)+PV(12%,2,0,-2000000,0)+PV(12%,3,0,-2000000,0)
Thank you for your answering.
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