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.
You have determined in your mind that you would like to have a business
of your own, although your father runs a family restaurant in your
local city. You have therefore, decided to have a medium size snack
and cocktails bar which will accommodate the cruise ship passengers
who visit your city. You plan to keep the business for five years
after which you will sell it off to your brother John for $2,000,000
and go off to do your Master’s Degree in the UK. Though you will be
occupying the establishment from your grandmother for free, you have
decided that you need to make some improvements to the property which
will cost you $1,500,000. Additionally, you will spend $275,000 in
bar stools, tables and decorations. If this space had been leased out,
it would have fetched a lease rental of $75,000 per year. You will
depreciate the assets over 7 years using MACRS. You have determined
that you would need an average cash balance of $15,000 and inventory
of $20,000 while Accounts payable should average $10,000. You plan to
borrow the money from a local bank and pay interest at a rate of 15
percent. To increase your chances of success at the business you plan
to have your cousin Johnathan to conduct a market survey which will
cost you $100,000. Your new venture will decrease the revenue your
family business will earn by $15,000 per year and you have agreed to
allow your father to take this amount from your allowance as a
shareholder of the family restaurant.
Revenues are projected to be $500,000 the first year and is expected
to increase by 20% the second year, 15% the third year and to continue
to increase at 10% thereafter. Fixed annual operating costs are
expected to be salaries of $110,000, Utilities $75,000, Food and
Liquor License is 15% of gross revenues and taxes are 40% of net
revenues.
Required-
What is the project NPV?
Step by step
Solved in 3 steps with 2 images
