Net Present Value, Mergers, and Acquisitions Case Project



Net Present Value, Mergers, and Acquisitions

Part 1: Investment Appraisal

Cash Flow

Years

Cash Flows

0

($3,219,000)

1

350,000

2

939,000

3

1,122,000

4

500,000

5

900,000

Present Value (PV) of Cash flows

PV of CF = CF1 / (1+r) 1 + CF2 / (1+r) 2 + CF3 / (1+r) 3 + CF4 / (1+r) 4 + CF5 / (1+r) 5

=> 350000/ (1.05)1 + 939000/ (1.05)2 + 1122000/ (1.05)3 + 500000/ (1.05)4 + 900000/ (1.05)5

=> 333,333 + 851,701 + 1,301,520 + 409836 + 703,125

=> PV = 3,599,515

Net Present value of the Project

NPV = Total PV of CF - Initial cash outflow

=> 359, 9515 - 3,219,000

=> NPV = 380,515

Analysis

From the above calculation, we can see that the net present value of the project is $380,515. It can be noted that the net present value of all the cash inflows over the years is more than the initial cash outflow at the start of the project. This shows that the project is feasible to invest in as it seems to be profitable in the upcoming years. Therefore the executives and the shareholders of Micron Technology are recommended to invest in this project.

Net Present Value

It is the most widely used method by the academicians, investors and financial managers to compare and select from a pool of investments. Net present value (NPV) is calculated in monetary terms. This method works on the basis of the concept of time value of money. It means that one pound sterling after one year is worth less than the same amount of money today. The reason is that the increasing inflation increases the cost of capital; as a result, the purchasing power of the same amount reduces as on today (Brealey and Habib, 2007, Pp. 12).

To incorporate the effect of increasing inflation and growth rate, this method discounts the future cash flows by a certain calculated factor to determine the PV of all the future CF. This amount is subtracted with the total amount of investment to calculate the Net present value if the particular investment. The discount factors are calculated in such a way as to reflect the risk of the business based on the weighted average cost of increasing capital to fund the business. Higher discount factors apply for the appraisal of riskier business ventures. The results of NPV are interpreted on the basis of the positive or negative value.

Relative profitability is assessed when an investment project has a higher NPV than the alternative investment projects. Like other investment appraisal methods, the techniques also make certain assumptions. However, the NPV method makes more realistic assumptions as against the other static models (Amachree, 2005, p. 150).

Assumptions

One of the most rigid and impractical assumptions of the NPV method is the existence of perfect capital markets.

The discounting rate assumes a uniform interest rate for all the debt obligations, regardless of the amount borrowed or the imposed limit. Moreover, it is difficult and complex to estimate the correct discount factor.

It ignores the impact if taxes and transfers.

It can be applied in case of one venture that produces only one ...