MODULE 5 FIN501

Module 5 FIN501 - Net Present Value, Mergers, and Acquisitions



Module 5 FIN501 - Net Present Value, Mergers, and Acquisitions

Part 1: Net Present Value

The Net Present Value (NPV) method is a standard method for evaluating investment proposals by the organizations working at any level. The explicit level recognition of the time value of money is accomplished by NPV methods as it uses the cash flow discounting technique. Because cash flows vary in amount and occur at different times, it is very difficult to appropriately postulate them for decision making (Paramasivan & Subramanian 2009). T-Mobile Corporation new project will cost $ 3,219,000. The cost of capital for the company is 4%. In calculating our Net Present Value (NPV) for the project, we take cost of capital (4%) as the discount rate.

Year

Cash Flow

Discount Factor

DCF

1

350,000

CF1 / (1+r)1

336538.5

2

939,000

CF2 / (1+r)2

868158.3

3

1,122,000

CF3 / (1+r)3

997453.9

4

500,000

CF4 / (1+r)4

427402.1

5

400,000

CF5 / (1+r)5

328770.8

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

PV of CF = 336538.5 + 868158.3 + 997453.9 + 427402.1 + 328770.8

PV of CF = $ 2958323.59

NPV of Project= Total PV of CF - Initial cash outflow

NPV of Project = 2958323.59 - 3,219,000

NPV of Project = $ -260,676

The NPV Concept

The varying cash flows at different period can be reported under equivalents present values and then compared (Paramasivan & Subramanian 2009). Calculation of that value involves the under mentioned steps: -

The forecasting to the cash flows should be carried out in accordance with the realistic assumption for the investment projects

When making discounts about cash flows, identification discount rates need to be carefully identified. When deciding on suitability of discount rates, opportunity cost of the capital is taken as the yardstick for investment project. This opportunity cost is the required rate of the return (RoR) expected by the investors against their investments having similar or equal risk

When using opportunity cost of the capital as discount rate, it is important that closest alternatives are taken. For instance, when comparing security 'A' and 'B', it must be ensured that both securities belong to the same sector.

All cash outflows are summed and subtracted from the total or aggregate cash inflows (Finch 2010). When Net Present Value model is set as basis for investment, the projects with highest positive net present values should be considered

Should T-Mobile Corporation take the New Project?

Within the positive net present values (NPVs), it is possible that two alternatives yield almost the same net return. This would then involve consideration of other factors than the NPV. The project that requires less operating and managerial capabilities will then be selected. For the purpose of finalising the decision of investment projects the management should stay clear regarding the factors that acceptance rule for investment projects is subject to the net present value i.e. the project with negative NPV should be rejected and the ones with positive NPV be selected / accepted (Paramasivan & Subramanian ...