The Caledonia Project: An Analysis of Net Present Value Calculation

10. What is the net present value (NPV) of a long-term investment project? Describe how managers use NPVs when evaluating capital budget proposals.

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.

NPV analysis uses future cash flows to estimate the value that a project could add to a firm’s shareholders. A company director or shareholders can be clearly provided the present value of a long-term project by this approach. By estimating a project’s NPV, we can see whether the project is profitable. Despite NPV analysis is only based on financial aspects and it ignore non-financial information such as brand loyalty, brand goodwill and other intangible assets, NPV analysis is still the most popular way evaluate a project by companies.

The relatively well posed project with promises of great future pay offs must be examined closely nevertheless to determine its true profitability. As such, the Super Project’s NPV must be calculated, however before we proceed we must acknowledge the relevant cash flows. The project incurred an expense of testing the market. This expense, however, must not be included in our cash flow analysis because it can be considered a sunk cost. This expense is required for ‘taking a temperature’ of the market and will not be recovered. Other sources of cash flow include:

2. Net Present Value – Secondly, Peter needs to investigate the Net Present Value (NPV) of each project scenario, i.e. job type, gross margin, and # new diamonds drills purchased. The NPV will measure the variance of the present value of cash outflow (drilling equipment investment) versus the future value of cash inflows (future profits), at the benchmark hurdle rate of 20%. A positive NPV associated with the investment means that the investment should be undertaken as it exceeds the minimum rate of return. A higher NPV determines which project scenario will have the highest return on cash flow, hence determining the most profitable investment in terms of present money value.

Evaluating the risks, calculating the probability of success, and factoring in the projected profit from sales will provide a clearer NPV to be compared with other projects in the

5. Estimate the project’s operating cash flows. (Hint: Again use Table 1 as a guide.) What are the project’s NPV, IRR, modified IRR (MIRR), and payback? Should the project be undertaken? [Remember: The MIRR is found in three steps: (1) compound all cash inflows forward to the terminal year at the cost of capital, (2) sum the compounded cash inflows to obtain the terminal

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.

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.

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.

There are several traditional methods that can be used in appraising investment decisions. For instance, the net present value method (NPV) which entails estimating the costs and revenues of a project and discounting these figures to get their present values. Projects with the biggest positive net present value are the ones chosen as they represent the best stream of benefits of investing in the project over and above recovering the cost of initiating the projects. The discount rate is another method which is similar to the net present value method but reflects more on the time preference. This approach may focus on the opportunity cost of

1. The net present value is the projects present value of inflows minus its cost. It shows us how much the project contributes to the shareholders wealth. The NPV of each franchise are:

This project evaluates the discounted Net Present Value which shows the estimated cash flow. The cash flow forecast is for 10 year which incorporates International complexities as well as the cost of capital.

The following paper analyzes a project from financial perspectives using the capital budgeting techniques like Net Present Value (NPV) and Internal Rate of Return (IRR).