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For the purpose of calculating the net present value of the project, an appropriate cost of capital has to be calculated at which free cash flows of the project should be discounted. Since the project will be solely financed by selling new shares, cost of equity will be used as the discount rate. Beta for the company can be assumed to be equal to average of the betas of the competitors of the company. This average beta value comes out to be 1.2. Risk free rate is 0.17% while risk premium has been estimated to be 6%. Thus by putting these values in CAPM formula, we can find the cost of equity for the company which is 7.39%.

The NPV compares the inflow of cash against the flow of cash to make the investment. With the cash flows occurring over a period of time, NPV also takes into account the cost of capital. The cost of capital or discount rate allows the company to weigh the present value of capital today with the investment capital’s present value. Futronics Inc. investment would have an NPV of $138,642.39. The NPV of this investment would add value to Futronics Inc.’ worth.

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

In an another article by this same author, we study the concept of Present Value and learn that the value of money decreases if it is paid at a date further into the future. For example, when interest rates are at 5% per annum, $50 paid 2 years later will be worth only $45.35 today. For this reason, it is better to use the Discounted Payback Period, which takes into consideration the present value of the future net cash flows of a business. If we use the discounted method in our latest example above, you will find that the payback period would be longer, like maybe 2 and a half years instead of just 2 years when using the simple non-discounted method. Why? Since the $50 per year in the future is worth less than the same amount paid today, you would need more years to get your

This is literally the amount of time required for the cash inflows from a capital investment project to equal the cash outflows. The usual way that firms deal with deciding between two or more competing projects is to accept the project that has the shortest payback period. Payback is often used as an initial screening method.

The net present value calculation is done with incremental cash flows. In this case, fixed costs are not incremental; only revenue and variable costs will be taken into consideration. Some of the information was provided, and some of the information was not. The spreadsheet includes the information that was provided. When the missing information is input, the spreadsheet will allow for proper comparison between the new manufacturing process and the old one. The idea is to compare which of these two options will deliver more cash flow over the life of the project to the company, adjusted for the discount rate. The missing data that needs to be filled in is as follows:

The payback period is less than 5 years; we can see it in the next graph, where the line crosses the X axis in the point 4.57, which is the calculated payback period.

Provides an indication of a project’s risk and liquidity. 2. Easy to calculate and understand. Weaknesses of Payback: 1. Ignores the Time Value of Money. 2. Ignores CFs occurring after the payback period.

Owers, 1997, p. 34). The discounted value of future cash flow (FCFi), expected of a project

Companies with limited capital invest in other companies in order to increase their wealth and they use payback period to finance their company. Payback period means the period of time that a project requires to recover the money invested in it. The payback period of a project is expressed in years it is calculated as:

To calculate the NPV ( Net Present Value) we discount the cash flow at the given discount rates

A net present value calculation is based on the principle that future cash flows are not worth as much as present day cash flows, because inflation devalues those future flows (Investopedia, 2012). This implies that there are a number of factors that influence the NPV analysis. For a given project say a hypothetical new factory many different factors will need to be taken into consideration.

The NPV consists of the sum of all the present values of the cash flows of an investment, both incoming and outgoing, with a given “r” as the opportunity cost (discount rate). Once we have obtained the result:

Discounted measures of project worth take time value of money under consideration. The most common means of doing this is to subtract year-by-year the costs from the benefits to get the “incremental net benefit stream” the so-called cash flow and then to discount that. To calculate discounted measures of a project worth, we need to choose a discount rate for calculating all methods. There are four types of discounted measures of project worth:

Note that the payback calculation uses cash flows, not net income. Also, the payback calculation does not address a project’s total profitability. Rather, the payback period simply computes how fast a company will recover its cash investment.