FINANCIAL MANAGEMENT

Financial Management

Financial Management

Question 1

Part A

Net Present Value Calculation

Net Present Value (NPV) is the most popular method when evaluating investment projects in the long term. The net present value determines whether an investment complies with the basic financial objective of maximizing investment or not. The net present value determines if the investment may increase or decrease the value of of the company (Helfert, 2002). 

 

Year 1

Year 2

Year 3

Year 4

 

£

£

£

£

Sales Revenue

450,000

540,000

600,000

570,000

 

 

 

 

Operating Costs

 

 

 

Consumables

90,000

102,000

114,000

114,000

Advertising

15,000

15,000

12,000

6,000

Staff Wages

168,000

168,000

180,000

180,000

Management Salaries

30,000

30,000

36,000

36,000

Overheads

6,000

7,500

7,500

9,000

Depreciation

97,500

97,500

97,500

97,500

Secretary Wage

24000

24000

24000

24000

Total Operating Costs

430,500

444,000

471,000

466,500

 

 

 

 

Net Income

19,500

96,000

129,000

103,500

 

 

 

 

Disposal Proceeds

 

 

120000

Depreciation

97,500

97,500

97,500

97,500

 

 

 

 

Net Cash Flow

117,000

193,500

226,500

321,000

NPV Analysis

 

 

Cash Flow

DF DCF

(510,000)

1.0000

(510,000)

117,000

0.8929

104,464

193,500

0.7972

154,257

226,500

0.7118

161,218

321,000

0.6355

204,001 NPV 13,941

Investment Measures NPV = 113,941 IRR =

20.68%

Assumptions and Project Analysis

Following assumptions have been taken in calculating the net present value for the Rooney PLC.

All the above information has been based on the assumption that no price changes will occur over the life of the project.

All cash flow appears at the end of year. However, capital expenditure for the purchase of equipment occurs at the beginning of year 1.

The company's real, risk adjusted cost of capital for this type of investment will remain same for the 4 years period at 12%.

The discount rate or discount used to calculate the net present value is 12% ,which is the rate of alternative capital cost of capital to be invested that is determined by using WACC. This presents a significant concern on the viability of the project to make an investment (Ehrhardt, 2010). Based on the discounting factor, it is necessary to diversify the business risks by investing in activities that provide more return (Shapiro, 2005).

All net cash flows have been discounted using 12% cost of capital that yielded discounted cash flow. Summing all these values resulted in calculation of NPV of 113,941 for four year project duration. Positive NPV of 113,941 pound shows that the decision of pursuing investment in project which will enable it to offer a trekking holiday in the Dominican Republic would be highly favourable for the Scholes PLC. Since the NPV value exceeds the zero threshold level, this shows that the project is highly attractive for the company. Investment in project which will enable it to offer a trekking holiday in the Dominican Republic will lead to increasing the net worth of the firm at the completion of the project.

Question 1

Part B

Net Present Value Calculation

By taking into account, the "best estimates" for specific and general inflation, provided by the directors, NPV for Scholes PLC is presented below.

 

Year 1

Year 2

Year 3

Year 4

 

£

£

£

£

Sales Revenue

459,000

550,800

612,000

581,400

 

 

 

 

Operating Costs

 

 

 

Consumables

95,400

108,120

120,840

120,840

Advertising

15,900

15,900

12,720

6,360

Staff Wages

176,400

176,400

189,000

189,000

Management Salaries

31,500

31,500

37,800

37,800

Overheads

6,000

7,500

7,500

9,000

Depreciation

102,375

102,375

102,375

102,375

Secretary Wage

25200

25200

25200

25200

Total Operating Costs

452,775

466,995

495,435

490,575

 

 

 

 

Net Income

6,225

83,805

116,565

90,825

 

 

 

 

Disposal Proceeds

 

 

126000

Depreciation

102,375

102,375

102,375

102,375

 

 

 

 

Net Cash Flow

108,600

186,180

218,940

319,200

Considering the technical and technological uncertainty in four years period, NPV results may change that would lead to turning the project unfeasible based on change in return cash flows. Due to 5% general inflation, direct impact will occur on the price of capital equipment and sale price of items after the project completion is calculated below.

Inflation

5%

Initial Equipment Cost

510000

Equipment Cost (New)

535500

Disposal Proceeds

120000

Inflation

5%

Disposal Proceeds (New)

126000

NPV Analysis

 

 

Cash Flow

DF DCF

(535,500)

1.0000

(535,500)

108,600

0.8929

96,964

186,180

0.7972

148,422

218,940

0.7118

155,837

319,200

0.6355

202,857

NPV

68,580

Investment Measures

NPV = ...