Umunat is considering investing $50,000 in a new machine with an expected The machine will have no scrap value at the end of 5 years. It is expected that 20,000 units will be sold each year at a selling price of $3.00 per unit. Variable production costs are expected to be $10,000 per year. Umunat uses a discount rate of 12% for investment appraisal purposes and expects investment projects to recover their initial investment within 2 years. Required: a. Explain why risk and uncertainty should be considered in the investment appraisal process. b. Calculate and comment on the payback period of the project. C. Evaluate the sensitivity of the project's net present value to a change in the following project variables: ● Sales volume Sales price Variable cost and discuss he use of sensitivity analysis as a way of evaluating project risk. d. Upon further investigation it is found that there is a significant chance that t expected sales volume of $20,000 units per year will not be achieved. The sa manager of Umunat suggests tgat sales volumes could depend on expect economic situations that could be assigned the following probabilities:
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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