Fin 571 Week 4

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.

The payback period looks at a project only until the costs have been recovered. This analysis tool is often ignored because it does not take into consideration the time value of money. The time value of money limitation of the payback period can be modified by using the discounted cash flows of a project for the analysis of when the outflows will be recovered.

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.

By computing the highest discount rate at which a project will have a positive NPV, the IRR method is supposed to assure that the actual rate of return on an accepted project is higher than the required rate of return.

Bixton Company’s new chief financial officer is evaluating Biston’s capital structure. She is concerned that the firm might be underleveraged, even though the firm has larger-than-average research and development and foreign tax credits when compared to other firms in its industry. Her staff prepared the industry comparison shown here.

Problem 1: Jonathon Barrs is a manager for Easy Manufacturing, LLC. He wishes to evaluate three possible investments. These investments are for the purchase of new machine tools from Germany, Japan, and a local US manufacturer. The firm earns 10% on its investments and they have a risk index of 5%. The chart below lays out the expected return and expected risks of the three projects.

It determines how long it takes an information system to pay for itself through reduced costs and increased benefits. Weather a project is economically feasible (chap#7 p#274) and the time it takes to recover the system’s cost is called the pay pack period. (P# 606)

Discounting a project at a reasonable rate, takes charge of the possible depreciation of the project value in the future. Estimated returns on a project can dwindle for so many reasons such as market fluctuations, price changes, technological innovations, depreciation in the value of money. Even the fixed assets of production are subject to the law of diminishing returns. A pipeline value can be fixed but that value depreciates over time due to ageing, wear

Thus, by year three the company will be making a profit off the investment as year three is 86.73 million profit by 55.35 cost giving the company a 31.38 million dollar surplus. Generally, a period of payback of three year or less is acceptable (Reference Entry) causing this project to be viable based off the payback analysis. Although, these calculations are flawed. The reason for this is because the time value of money is not taken into effect when calculating payback periods which is where IRR can further assist in a more realistic financial picture (Reference Entry).

Payback period is the simplest method of the capital budgeting. It does represent the actual amount of period needed for the cash flow that is produced by the investment in repaying back the cost of the original investment. The advantage of this analysis is that it has the provision of insight into liquidity of the investment. Unfortunately, this analysis only includes cash flow payments only within the payback period but not those that are beyond(Hofstrand, 2013).

The PAYBACK technique is based on cash flows and it measures the time which is required for a proposal’s initial cash outflow to equal its cash inflow generated by the investment, the solution is expressed in years and month or days.

After a new competitor from overseas entered Sonora’s furniture market and one of the largest retailer in the nation opened headquarter in Sonora, Guillermo's Furniture store experienced serious business problems. As a result, Guillermo’s profit margins shrink, as prices fell and costs rose. (UOP, 2009) After conducting some research Guillermo came to the conclusion that he has at least three alternative courses of action to proceed:

Project C is another project I recommend to invest in although the payback period of over the cut-off by six months. However, this project has a highly acceptable internal rate of return and accounting rate of return. The net present value is large, which would add a lot of value to the company. In my opinion, these three other factors are large enough to outweigh the payback

• Propose an approach for how profitable decisions can be made by using cost of capital consideration within the corporate environment.

Financial concepts can be used when a company is considering various options. Which options cost more and which options will result in higher gains are two of the financial factors that affect decisions. In the University of Phoenix (n.d.) scenario, Guillermo’s Furniture Store has several options to consider which can help bring the revenues back to the company. This paper explains and relates three basic principles and concepts to the scenario.