Caledonia Problem

Free cash flows of the project for next five years can be calculated by adding depreciation values and subtracting changes in working capital from net income. In 2010, there will be a cash outflow of $2.2 million as capital expenditure. In 2011, there will be an additional one time cash outflow of $300,000 as an advertising expense. Using net free cash flow values for next five years and discount rate for discounting, NPV for the project comes out to be $2907, 100. The rate of return at which net present value becomes zero i.e.

EEC calculated the amount of time involved the anticipation of its cost ($3 million). The timeline in recovering their cost of investment ($2 million) initially for the foundation of this investment any profit made in the future of this investment will be justified as a profit for the company. If EEC can anticipate a fast return on its investment it is a profitable wise decision in making the investment financial, it is considered to be an easier way of formulating investments financially. On the basis of one year all cash flows is added together equal to the sum of $2 million originally invested, then it is divided by the annual cash flow of $500,000. The calculation of the payback period would equal four years. After this time frame any financial proceeds will be considered profitable for the company. I conclude that the timeframe is adequate in comparison of the investment in this worthwhile investment financial venture for the company.

We should accept the project because of the positive NPV and high IRR. We will gain $532 million in wealth which is a big money on the scale like this. The company has a bond rating of AA that makes the risk relatively low. So we should definitely say yes.

Interstate Manufacturing is considering either replacing one of its old machines with a new machine or having the old machine overhauled. Information about the two alternatives follows. Management requires a 10% rate of return on its investments.

Compute the incremental cash flows of the investment for each year. (Do not round intermediatecalculations. A negative answer should be indicated by a minus sign.)

The present value of an outlay in perpetuity for a particular project can be calculated as follows:

Account for time. Time is money. We prefer to receive cash sooner rather than later. Use net present value as a technique to summarize the quantitative attractiveness of the project. Quite simply, NPV can be interpreted as the amount by which the market

Net Present Value (NPV) calculates the sum of discounted future cash flows and subtracting that amount with the initial investment of the project. If the NPV of a project results in a positive number, the project should be undertaken. It is the most widely used method of capital budgeting. While discount rate used in NPV is typically the organization’s WACC, higher risk projects would not be factored in into the calculation. In this case, higher discount rate should be used. An example of this is when the project to be undertaken happens to be an international project where the country risk is high. Therefore, NPV is usually used to determine if a project will add value to the company. Another disadvantage of NPV method is that it is fairly complex compared to the other methods discussed earlier.

6.The Year 0 net investment outlay for the project is $-475,000. This computed by adding the price of the machinery, installation, shipping, and the change in net working capital. The non-operating cash flow when the project is

The company should be interested in incremental after-tax cash flows. The incremental cash flow will allow Caledonia to see the profits or losses of a project by comparing cash flows with and without the project on an after tax basis.

4. Based on the information provided in the case, our group calculated the NPV for the project under both tax environment and tax-free condition, respectively, by using the excel spreadsheet and the NPV function. (For a detailed calculation of NPV, please refer to Appendix Under 15-yr.) According to our calculation, we have the following results: In the first case scenario, which the firm is in a tax environment (35% income tax), the NPV of the project equals to -$6,366,054.53

The actual production would begin in the third quarter of this year, therefore only half year’s depreciation should be counted on Equipment and IT communication in 2004 (According to Appendix A). The following years (2005-2008) incremental cash flows are computed by the same method. However as the IT equipment and furnishings would be depreciated on a straight line basis over 3 years, thus in year four (2007), there would be only half a year’s deprecation left and after that it will be used up. The last year’s net cash flow in 2009 should be included the extra terminal Value on that year, which includes 24 years’ residual value on building and one year and a half residual value on equipment totaled $2,990,412 with two assumptions of by using residual book values for the building and operating equipment and there will be no further NWS advantage after year 2009. Finally, by obtaining 6 years’ incremental cash-flows and discounting them back to time zero (with the estimate rate of return by 15%) lessing initial cost to get an appealing NPV of $1190528 (Luehrman, p. 3).

As we have mentioned above, the relevant cash flows to calculate the NPV of the project are the incremental cash flows, which mainly include the operating cash flows and the investment cash flows.

The cash flows from a project must be reduced by the amount of taxation payable on these cash flows. However, the taxation savings arising from the capital allowances (annual writing down allowances) reduce the taxation payments. Because taxation payments do not occur at the same time as the associated cash flows, the precise timing of the taxation payments should be identified to calculate NPV.

This analysis will determine whether or not the project is worth pursuing using a net present value (NPV) approach.