BUS 5111 - Financial Management

Written Assignment Unit 2

3 February - 9 February

Dr. Kirk Fischer

Professor
Instructions for submission

You and your lifelong friend are partners together in the promotional materials business. That is, when marketing firms and their clients begin
advertising or public relations campaigns, they come to your company to obtain the materials and products that would support the ad campaign.
Examples of the materials and products you supply are printed posters, signs, T-shirts with printed logos, key chains, and other such items. You
supply these items by procuring them from other sources or in some cases you manufacture them using various equipment in a warehouse you
use near the center of the city. Your company’s name is WePROMOTE.

You and your business partner are planning the next major project for your company. The project is a significant step in the growth of your firm
in that the project will generate cash inflows into the firm for many years into the future. However, there will be a large investment of funds
required by the firm to launch the project. The planning is in its preliminary stages where the numbers and other data are gross estimates.
Despite the “fuzzy numbers”, you and your partner still need to decide whether the project will be worth pursuing.

The following is some of the estimated data you have:

• You both decided to finance the project using your own funds.
• The cost of the equipment will be $80,000 and this cost is incurred prior to any cash is received by the project.
• The expected cash inflows are the most variable of the estimates. Your partner is convinced that the firm will receive $14,000 annually
for 7 years. You have your doubts. You think it is more reasonable that there will be cash inflows of $14,000 in year 1, then inflows of
$16,000 from years 2-4, and then inflows of $17,000 for years 5-7.
• You both agree that after 7 years, the equipment will stop working and can be sold for its parts for about $5,000.
• You both consider a discount rate of 7% but remain open to other future possibilities.

You trust your partner’s instincts and agree to start analyzing the feasibility of the project. The first step is to perform net present value (NPV)
calculations for the project using your partner’s estimates and then using your estimates.

• Perform the two NPV calculations and provide a narrative of how you calculated both computations and why. Your answer must be
justified.
• Present your calculated answers in schedule format (a table) along with your narrative. Microsoft Excel is also recommended for
calculating and creating a table (your schedule).
• Then provide a summary conclusion on whether you should continue to pursue this business opportunity.
• Finally, assuming your partner remains unconvinced of your conclusion, present relevant points of your analysis that you believe are
compelling and persuasive in supporting your position.
•
Papers will be assessed using the following criteria:

• Accurate NPV calculations are provided

• A narrative that fully explains how NPVs were calculated and why is included
• A clear, logical summary and conclusion is given
• A compelling and persuasive analysis in supporting your position
 Introduction

If cash inflows and cash outflows are compared over a period of time, the difference is known as net present value (NPV)

(NPV). As part of capital budgeting and investment planning, the net present value (NPV) financial ratio is used to assess the

profitability of a planned investment or project (Burksaitiene, 2009)

An old prover states that a bird in the hand is worth two in the bush which means that it's better to hold onto something

you have rather than take the risk of getting something better which may come to nothing.

As the future cash flows in an NPV calculation are "discounted," they represent the time worth of money in the present.

To put it another way, early cash flows are valued more highly than those that are predicted in the future.

Because of such, the NVP was determined based on the data shown in the table below. In both cases, the present value

interest factor (PVIF) was employed. This is a formula used to estimate the current value of a future sum of money. PVIFs are

frequently shown as a table of values for various time periods and interest rate combinations. The discounted cash flow was

calculated by multiplying the PVIC by the Cash Flow for each year.

NET PRESENT VALUE COMPUTATIONS FOR WEPROMOTE

My Result Friend’s Result

PVI
Years F Cash Flow ( R ) PV of CF Cash Flow ( R ) PV of CF
0 1 (80,000) (80,000) (80,000) (80,000)
1 0.935 14,000 13,090 14,000 13,090
2 0.873 16,000 13,968 14,000 12,222
3 0.816 16,000 13,056 14,000 11,424
4 0.763 16,000 12,208 14,000 10,682
5 0.713 17,000 12,121 14,000 9,982
6 0.666 17,000 11,322 14,000 9,324
7 0.623 22,000 13,706 19,000 11,837

Net Present Value 9,471 (1,439)

*Scrapped vale of $5000 was added to the cash flow

The following formula is used to calculate NPV:

Where:

Rt =Net cash inflow-outflows during a single period t.

i=Discount rate or return that could be earned in alternative investments.
t=Number of timer periods.

NPV was calculated by reducing the initial investment from the present value of future cash flows. As per both the
assumptions initial investment at year 0 is 80,000 means a cash out flows of 80,000 at year 0, so showed with a negative sign.
As per partner's assumptions the annual cash flow for year 1-7 is 14000, which is multiplied by the present value interest
factor at 7% for the respective year to get the present value. While as per my assumption the cash inflow at year 1 is 14,000,
year 2-4 is 16,000 and year 5-7 is 17,000, which are again multiplied by the present value interest factor at 7% for the
respective year to get the present value. In the end the terminal cash flow at year 7 is 5,000 for both the assumptions, which
is then discounted at 7%. Present value of all the cash flows is added to get the NPV.

Recommendation

Since NVP has a negative value, this indicates that we cannot proceed with this project, according to the aforementioned

estimates. Because my NVP calculation yielded a good result, I believe the project can move forward as planned. The NPV was

projected to be low or negative because the cash flow from my friend's plan remains constant year after year while the PVIC is

decreasing.

The primary benefit of using NPV is to consider the concept of time value of money, i.e. a today's money has a higher

value than it would have in the future because of inflation and the potential returns of alternative investments. While assuring my

friend that using NPV analysis that makes assumptions about future events that may not be reliable is risky, I would encourage him

to understand that a dollar earned today is worth less than a dollar earned in the future. The NPV formula includes a discount rate

to account for this.

Increased market share and increased cash flow are expected as the company grows. As a result, it would be naive to

assume that cash flows would remain constant during the course of the project. Also, prior to deciding whether or not to proceed

with the project based on preliminary estimations, more investigation should be done.
 References

Balen, R. M., Mens, H. Z., & Economides, M. J. (1988, November). Applications of the net present value (NPV) in
the optimization of hydraulic fractures. In SPE Eastern Regional Meeting. OnePetro.

Burksaitiene, D. (2009). Measurement of value creation: Economic value added and net present value. Economics and
Management, (14), 709-714.

Finance for Managers (2012). Lardbucket Book Project. Licensed under a Creative Commons by-nc- sa 3.0
http://creativecommons.org/licenses/by-nc-sa/ 3.0/.Will K., (2019). Net Present Value (NPV). Investopedia.
Retrieved from https://www.investopedia.com/terms/n/npv.asp

Shrieves, R. E., & Wachowicz Jr, J. M. (2001). Free cash flow (FCF), economic value added (EVA™), and net
present value (NPV):. a reconciliation of variations of discounted-cash-flow (DCF) valuation. The
engineering economist, 46(1), 33-52.

Wetekamp, W. (2011, September). Net Present Value (NPV) as a tool supporting effective project management.
In Proceedings of the 6th IEEE International Conference on Intelligent Data Acquisition and Advanced
Computing Systems (Vol. 2, pp. 898-900). IEEE.