Introduction and Review
Good morning everyone, it is my pleasure to meet again the board members for the third week. As I introduced myself before, I am AbdulRahman Muslihi, a health services manager, with the Certified Public Accounting Firm, Pennypacker & Vandelay, LLC. As we have seen last week, Soft Returns ' 'indirect benefits ' ' ROI can accurately work as indicators to measure intangible benefits, through the three steps: Identifying a process improvement opportunity, create a formula to calculate the benefits, and determine the costs of the process and the net benefits. This week, however, I am going to discuss with you "The Justification of Capital Expenditure".
In this subject, we are going to see the net present value and the
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Attainment of Key Decision Criteria
There are two common ways, which are: NPV and Profitability index, are used to evaluate and review investments, through calculating the capital expenditure to select the profitable project.
Net Present Value analysis is really common budgeting tool that show the differences between the present value of revenues and the present value of expenses. The project can be profitable when the net present value is positive. In other words, the present value of revenues is greater than the present value of expenses. Profitability index is another tool for evaluating investment projects, which is the ratio of the PV of benefits on the PV of costs. Project can be beneficial if the profitability index is greater than 1. Also, it has the same idea as NPV that In other words, the present value of benefits is greater than the present value of costs. However, these two methods (NPV and Profitability Index) have been used to evaluate the proposal of implementing EMR.
Financial Analysis
The following table demonstrates the PV of costs, the PV of benefits and the NPV respectively, over 5-year period for the investment:
The present value of a cost /benefit is defined as
Present Value of cost/benefit = Cost or Benefit in Year n (1 + discount rate) n
So, n is the year number. The discount
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.
Finally, in order to complete a more accurate comparison between the two projects, we utilized the EANPV as the deciding factor. Under current accepted financial practice, NPV is generally considered the most accurate method of predicting the performance of a potential project. The duration of the projects is different, one lasts four years and one lasts six years. To account for the variation in time frames for the projects and to further refine our selection we calculated the EANPV to compare performance on a yearly basis.
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
Critically reflect on the importance of capital budgeting. Why is this heated subject in many boardrooms? How does capital budgeting promote the financial health of an organization? How will you use the financial techniques you have learned this week to promote the financial health of your organization?
Cash inflows and outflows can occur at any time during the project. The NPV of the project is the sum of the present values of the net cash flows for each time period t, where t takes on the values 0 (the beginning of the project) through N (the end of the project).
Due to the NPV being a positive number listed in the above calculations it is my belief and will be the advantage of the company in question to go ahead with the project and expect a great return for their efforts. Cash flow is one of the most important facets of an organization. Net present value also known as (NPV) can be calculated before or after taxes ( CCIM Institute, 2007).
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 present value of the net incremental cash flows, totaling $5,740K, is added to the present value of the Capital Cost Allowance (CCA) tax shield, provided by the Plant and Equipment of $599K, to arrive at the project’s NPV of $6,339K. (Please refer to Exhibit 4 and 5 for assumptions and detailed NPV calculations.) This high positive NPV means that the project will add a significant amount of value to FMI. In addition, using the incremental cash flows (excluding CCA) generated by the NPV calculation, we calculated the project’s IRR to be 28%. This means that the project will generate a higher rate of return than the company’s cost of capital of 10.05%. This is also a positive indication that the company should undertake the project.
In fully investigating all of our calculations we are fully invested in using the Net Present Value figures we calculated as a means of ranking the eight projects. In doing so we found reasons in which why the Net Present Value was our benchmark for ranking the projects and why we did not use the Payback Method. The Payback Method ignores the time value of money, requires and arbitrary cutoff point, ignores cash flows beyond the cutoff date, and is biased against long-term projects, such as research and development and new projects. When comparing the Average Accounting Return Method to the Net Present Value method we found that the Average Accounting Return Method is a worse option than using the Payback Method. The Average Accounting Return Method is not a true rate of return and the time value of money is ignored, it uses an arbitrary benchmark cutoff rate, and is based on accounting net income and book values, not cash flows and market values. Plain and simply put, the Net Present Value method is the best criterion to use when ranking these eight
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:
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
NPV and IRR: When examining the NPV and the IRR of the Merseyside project, the numbers were very attractive. It had a positive net present value and an IRR above 10 percent. By these numbers, along with others,
The value of an organization is what the organization is worth. It’s value today is available cash, expected future cash flows which would accrue to the owners of the firm. In the case of an organization which has ownership divided into shares, the value of the organization is the total value of the shares. This research is being performed for the Honorable Mayor, the City Council, and the Board of Directors, to address a host of issues to solve the health needs of an African Country. One of the research objectives is to put forth a “proposal, an expenditure plan, and assessing key objectives like fund accounting, and financial controls. This includes control and management of public expenditures, government financial reporting requirements”, and budgets to make good administrative decisions for a large Not-for-Profit Health Relief Organization. For the purpose of this writing, the organization of discussion is the (HRO), The Health Relief Organization. One of the main research “objectives is to propose an expenditure plan assessing the key objectives along with fund accounting, financial controls, analyzing financial statements, and budgets for making appropriate