FINANCIAL MANAGEMENT

Financial Management

Financial Management

Part A

Introduction

Thomson is a food manufacturing company. The company is planning to expand its production by purchasing new machinery. The company has done all the production planning and forecasted the sales of the company. The final decision rest with the finance manager as he is going to decide based on the four-appraisal methods. This will help the company to know whether the company can get considerable return from the investment. The four appraisal methods are as following.

Net Present Value

The total future value that is discounted at a certain cost of capital is called net present value. These discount rates are used as per the company cost of capital. This method is based on the principal that the dollar worth today is not the same in the future. Therefore, the future cash flow is not the same as they are today (Corbacioglu and Laan, 2005, Pp 45-63). To counter this problem, this method solves the time value of money. This is very beneficial for business in understanding the real value of their future cash flows. This method is mostly used in long-term project, as the cash is received over a long period and in different tranches. To calculate the future cash flow the company has to discount the cash flows and then subtract it from the initial investment. The benefit of this action would be that the company could know whether to pursue the project or not.

We are going to look at the NPV of the given proposal. The Net present value of the given proposal is negative in value that is its has a negative NPV of $72553 (Corbacioglu and Laan, 2005, Pp 45-63). This is because the company has initially invested $300,000. The future cash flows from this project was $ 80,000. The project had annual cost of $ 20,000 for running the machine. The cash flows are discounted using the 10% rate of capital. Thus, the discounted cash flows are $54,545, $49,587, $45,07,40981 and 37255. These are than subtracted from the initial investment. This gives NPV of the project that is $(72553). Thus by looking at the NPV of the project, we can say that the project is not feasible to pursue.

 

Discount rate

10%

 

 

 

 

 

 

 

 

 

Year

0

1

2

3

4

5

 

Cash flow

 

 

 

 

 

 

Investment

$300,000

 

 

Annual Revenue

 

$80,000

80,000

80,000

80,000

 

Annual Running Cost

$20,000

20,000

20,000

20,000

 

Depreciation

 

$90,000

90,000

90,000

90,000

 

Cash Flow Before tax

($30,000)

-30,000

-30,000

-30,000

 

Tax (Not Given)

 

$ -

-

-

-

 

Depreciation Add Back

$90,000

£ 90,000

£ 90,000

90,000

 

Cash Flows

 

60,000

60,000

60,000

60,000

 

Salvage Value

60,000

 

Net Cash Flows

$60,000

60,000

60,000

60,000

60,000

 

Discount Factor

1

0.9090909

0.8264463

0.7513148

0.6830135

0.620921

 

Discounted CF

($300,000)

$54,545

$49,587

$45,079

$40,981

37255.28

 

 

 

 

Investment Measures

 

 

 

 

NPV =

($72,553)

 

 

 

IRR =

0.000000%

 

 

 

Excel calculation of IRR =IRR (($300,000) 60,000 60,000 60,000 60,000 60,000).

Internal Rate of Return

This is the discount rate which is used in the process of capital budgeting. This method makes the future cash flow zero at a given rate of return. This is the case that higher the rate of return of the project the better it is for the company. This method is used in several processes for ranking the project (Corbacioglu and Laan, 2005, Pp 45-63). The project, which has the highest IRR amongst a given project, is suitable to ...