NPV Analysis and Capital Budgeting for Project Investment Decisions

This project provides a comprehensive NPV analysis, evaluating a project's financial viability. It begins by defining incremental sales and cash flows, distinguishing between positive and negative impacts on stakeholder value. The analysis considers relevant factors such as interest expenses, s...Read More

Running head: NPV ANALYSIS
NPV Analysis
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1NPV ANALYSIS
Table of Contents
Answer:......................................................................................................................................2
Part 1:.....................................................................................................................................2
Part 1a:...................................................................................................................................2
Part 1b:...................................................................................................................................2
Part 1c:...................................................................................................................................2
Part 1d:...................................................................................................................................3
Part 2:.....................................................................................................................................3
Part 3:.....................................................................................................................................4
Part 4:.....................................................................................................................................4
Part 5:.....................................................................................................................................5
Part 6:.....................................................................................................................................5
Part 7:.....................................................................................................................................6
Bibliographies:...........................................................................................................................7

2NPV ANALYSIS
Answer:
Part 1:
The incremental sales is defined as the cash flows which is generated by the company
when it accepts a project which creates cash flows. The incremental cash flows can be
positive or negative, where a positive cash flow creates value for the stakeholders of the
company while negative cash flows reduce the value for the stakeholders of the company.
Part 1a:
The interest expense for a project is incurred when the project is funded with debt,
thus a project can lead to an increase in the incremental cash flow and the interest expense.
Thus the interest expense needs to be reduced from the project cash flow when calculating
the incremental expense. However, dividends have no effect on the project cash flow and no
treatment for the same is to be done to calculate the project cash flow.
Part 1b:
The expense which is incurred by the company to change the production line is a sunk
cost. Sunk cost is the cost which is incurred to make the project viable for operations before
the decision to undertake the project is undertaken. Thus this cost has incurred and if the
project is rejected then cannot be recovered. Hence this cost is not to be taken for project
analysis as whether the project is accepted or rejected the cost has incurred and hence the cost
is not taken in the project analysis.
Part 1c:
The extra plant space which can be leased out to another firm leads to generation
additional cash flow for the company. Thus the space creates additional revenue and should
be included in the analysis of the project. This can be done by taking the additional revenue

3NPV ANALYSIS
and adding to the revenue and would lead to an increase in the incremental cash flow of the
company.
Part 1d:
The undertaking of a new project can lead to reduction of other products of the
company. This is termed as the word cannibalization as the new product reduces the sale of
existing products which is a loss of revenue for the company. This should be taken as cost for
the company and should be reduced from the revenue of the company. Thus this would lead
to a reduction in the incremental cash flow of the company.
Part 2:
The sales and the cost of the project is calculated in the figure below for the four
periods of analysis,
Figure 1: Sales and Cost
Source: By the Author
The sales and the cost of the first year of operation is $210000 and $105000
respectively which increases at a rate of 3%, which includes inflation. Inflation is taken into
account for the calculation since with the passage of time the price of the goods sold and
produce increases which needs to be incorporated in the calculation to calculate an estimate
of value which would be created for the company.

4NPV ANALYSIS
Part 3:
The net working capital for the project is 12% of the sales which is incurred in a year,
as the sale revenue for the project is increasing the net working capital of the project is
increasing which is highlighted in the figure below,
Figure 2: Net Working Capital
Source: By the Author
Part 4:
The depreciable basis of the project is calculated by undertaking all the expense
which is incurred at the initial stage of the project which involves the initial investment, the
shipping expense and the installation cost. While the depreciation is charged to the project at
the MACRS 3 year Schedule.
Figure 3: Depreciation Schedule
Source: By the Author
Thus the various rates at which the depreciation is charged along with the book value
which is at the end of the project is highlighted in the figure.

5NPV ANALYSIS
Part 5:
The cash flow from the salvage value is calculated by using the formula which is
provided below,
Terminal Cash Flow = Salvage Value – (Salvage Value – Book Value)*(1- Tax Rate)
Thus the terminal cash flow using the salvage value of $20000 and the book value of
the asset as $70109.76 and the tax rate of 26%. The cash flow is $ 57081.22.
Part 6:
The table highlighting the net cash flow from the project is highlighted in the figure
below,
Figure 4: Cash Flow after Tax
Source: By the Author

6NPV ANALYSIS
Part 7:
The relevant measures which are taken from the calculation of the cash flows is
highlighted in the figure below,
Figure 5: Relevant measures for decision
Source: By the Author
The NPV of the project is $16217.84, while the IRR is 12% which highlights the
project is generating the value for the company as the both measures are positive. The
profitability index highlights the project is greater than 1, hence return is being created by the
undertaking of this project. The payback period is 3.45 years while the discounted payback
period of the project is 3.85 years.
Thus since the economic life of the project is 4 years and the payback period is less
than the economic life the project should be undertaken by the company.

7NPV ANALYSIS
Bibliographies:
Hadidi, L.A. and Omer, M.M., 2017. A financial feasibility model of gasification and
anaerobic digestion waste-to-energy (WTE) plants in Saudi Arabia. Waste management, 59,
pp.90-101.
Marchioni, A. and Magni, C.A., 2018. Investment decisions and sensitivity analysis: NPV-
consistency of rates of return. European Journal of Operational Research, 268(1), pp.361-
372.
Rich, S.P., Rose, J.T. and Delaney, C.J., 2018. Net Present Value Analysis in Finance and
Real Estate: A Clash of Methodologies. Journal of Real Estate Portfolio Management, 24(1),
pp.83-94.
Rodrigues, M.I., 2020. FINANCIAL ANALYSIS OF INVESTMENTS IN FOREST
CONCESSION FOR AMAZON BRAZILIAN BY DETERMINISTIC AND STOCHASTIC
METHODS. CERNE, 25(4), pp.482-490.