Financial Analysis Using Net Present Value Finance Essay

Present Value ( PV ) is the current value of a future sum of money or a series of payments, evaluated at a given involvement rate. The construct of present value is based on the thought that money has clip value. Time value merely means that if an investor is offered the pick between having $ 1 today or having $ 1 in the hereafter, the proper pick will ever be to have the $ 1 today because this $ 1 can be invested in some chance that will gain involvement, which is ever preferred to having merely $ 1 in the hereafter. In this sense, money can be said to hold clip value.

The involvement rate or cost of capital used to calculate present values of future hard currency flows is called the price reduction rate. Present values are straight related to the hereafter hard currency flows and reciprocally related to the price reduction rate, R, and clip, t. the higher the future hard currency flows, the higher the PV and the higher the price reduction rate and longer the term the lower the PV. Cash flows happening at different clip periods are non comparable for fiscal determination devising. The hard currency flows must be clip adjusted, at an appropriate price reduction rate, normally to the present for comparing, summing up, or other analysis.

PV Formula:

2. Net PRESENT VALUE ( NPV )

NPV will ever look as a dollar sum in one of three ways: greater than zero, zero, or less than zero.

1. When NPV & gt ; 0, it means the discounted value of future hard currency flows is greater than the initial investment.It should be accepted

2. When NPV =0, it means the discounted value of future hard currency flows is equal to the initial investing.

3. When NPV & lt ; 0, it means the discounted value of future hard currency flows is less than the initial investing. The undertaking should likely be rejected because hard currency flows will besides be negative

Beginning: Jeffrey A. Cohen ( 2005 ) , Intangible Assets, Business & A ; Economicss

Harmonizing to Ross, Westerfield and Jordan, The difference between an investing ‘s market value and its cost is called the net present value of the investing, abbreviated NPV. In other words, net nowadays value is a step of how much value is created or added today by set abouting an investing. ( Ross, Westerfield and Jordan 2006 p.262 )

NPV Formula:

In add-on to the expression, net present value can frequently be calculated utilizing tabular arraies.

3. CALCULATION AND ANALYSIS

Calculate Cost of Capital is 10 % =0.10

= 1 =0.6830 =0.4665

= 0.9091 =0.6209 =0.4241

= 0.8264 =0.5645 =0.3855

= 0.7513 =0.5132

Discount factors 10 % Table

Year

0

1

2

3

4

5

6

7

8

9

10

Factor

1

0.9091

0.8264

0.7513

0.6830

0.6209

0.5645

0.5132

0.4665

0.4241

0.3855

Option 1

Year

Cash Flow ( $ )

Discount Factor @ 10 %

Present Value

1

-11,400,000

0.9091

-10,363,740.0000

2

70,949

0.8264

58,632.2536

3

80,300

0.7513

60,329.3900

4

80,300

0.6830

54,844.9000

5

80,300

0.6209

49,858.2700

6

80,300

0.5645

45,329.3500

7

80,300

0.5132

41,209.9600

8

80,300

0.4665

37,459.9500

9

80,300

0.4241

34,055.2300

10

80,300

0.3855

30,955.6500

Residual Value

11,870,074

0.3855

4,575,913.5270

Entire PV ( Option 1 ) = 412,674.9536

NPV ( Option 1 ) = -5,375,151.5194 & lt ; 0

Option 2

Year

Cash Flow ( $ )

Discount Factor @ 10 %

Present Value

1

-3,579,000

0.9091

-3,253,668.9000

2

-503,617

0.8264

-416,189.0888

3

-505,025

0.7513

-379,425.2825

4

-510,180

0.6830

-348,452.9400

5

-515,763

0.6209

-320,237.2467

6

-521,809

0.5645

-294,561.1805

7

-528,357

0.5132

-271,152.8124

8

-535,449

0.4665

-249,786.9585

9

-543,129

0.4241

-230,341.0089

10

-551,446

0.3855

-212,582.4330

Residual Value

5,727,858

0.3855

2,208,089.2590

Entire PV ( Option 2 ) = -2,722,728.9513

NPV ( Option 2 ) = -3,768,308.5923 & lt ; 0

Option 3

Year

Cash Flow ( $ )

Discount Factor @ 10 %

Present Value

1

0

0.9091

0.0000

2

-660,000

0.8264

-545,424.0000

3

-660,000

0.7513

-495,858.0000

4

-660,000

0.6830

-450,780.0000

5

-660,000

0.6209

-409,794.0000

6

-660,000

0.5645

-372,570.0000

7

-726,000

0.5132

-372,583.2000

8

-726,000

0.4665

-338,679.0000

9

-726,000

0.4241

-307,896.6000

10

-726,000

0.3855

-279,873.0000

Entire PV ( Option 3 ) = -3,573,457.8000

NPV ( Option 3 ) = -3,573,457.8000 & lt ; 0

Analysis

It can be seen that NPV of Option 1 have a little value ( the least value ) and 5,375,151,5194 In the same clip, NPV of both Option 2 and 3 are 3,768,308,5923 and 3,573,457,800 severally. If refer to NPV, option 1 is unacceptable alternate. To be a consequence of NPV is the smallest value ( minimal value ) with in 10 old ages. That ‘s average, This option should n’t consideration travel over,1 ( in option ) hard currency flow in the terminal of twelvemonth have got a biggest value ( to be effect ) It might be do the company face of liquidness job.In add-on, If will lose their chance as a hard currency for investing in others undertakings. That it can be achieve move value to company.However, Residual Value in the last twelvemonth of twelvemonth of option 1 highest value ( hold biggest ) but it does n’t do NPV interested in to hold a determination devising in investing. If comparing with initial investing in the terminal at twelvemonth 1.

In the option 2 and 3, have closed value and the different about 194,850. But both of these options are negative. In option 2, an initial cost of the investing in the terminal of twelvemonth 1 is ( -3,579,000 ) . One 3rd value of 1st option, in the same clip of the undermentioned twelvemonth in the same option. Installation costs are expected to be paying $ 500,000 per twelvemonth. Therefore, Company does n’t hold to pay that sum in the terminal of twelvemonth and more chances for investing or other options. So, Company has chances to return hard currency on other investings. However, When we perceive NPV this option is ( -3,768,308.5923 ) which is interesting than option1 and the residuary value besides have more value than initial investing every bit good. It does n’t intend that option2 is n’t that much interested than option1 because the consequence remains in negative value.

In option 3, NPV is the least negative value. This undertaking besides does n’t hold an initial investing in “ End of twelvemonth 1 ” but the company has to pay rent or rental more than other options about $ 600,000 to $ 726,000 per twelvemonth. This means company has to pay along the

period of undertaking. Meanwhile, company does n’t hold a residuary value in the last period of concluding twelvemonth. In the other manus, company will hold alternate to take hard currency in others investing. Furthermore, it can be company ‘s advantage in tax-deductible when company has to pass all whole twelvemonth disbursals.

As a consequence, the consideration of these 3 options, Harmonizing to Jeffrey A.Cohen theory of NPV, It can be seen that all these 3 options are non the best option to investing. Because of these 3 options NPV are negative. However, if the company has to make up one’s mind one of three options. Option 3, it seem to be the best reply. For the ground of the company hold given in above and it is the subtraction minimum NPV is -3,573,457.8000. The best proposal is the 1 with the highest ( most positive ) even if that NPV is negative.