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The medium size company Amazing Integration Ltd
The medium size company Amazing Integration Ltd. was preparing to invest into several projects to increase its company’s value as well as to expand its market share and to integrate the new technology.
The recently elected CEO of the company, Mr. Jason Smith, asked the CFO and other financial managers to present the matrix for projects evaluation. He was summarizing the financial expert’s presentation and got the following summary: if a company invests in a profitable project, it will increase the owners' equity and the value of the company by the amount equal to the NPV. If a company invests in an unprofitable project, it will decrease the owners' equity and the value of the company by the amount equal to the NPV. NPV has also a similar effect on stock prices. Projects with a positive NPV increase the price of a stock by an amount equal to the NPV per stock, whereas project with a negative NPV decrease the price by an amount of the NPV per stock.
Amazing Integration Ltd. is considering whether or not to proceed with an investment project that requires an initial outlay of USD 100,000. The after-tax cash inflows are estimated to amount to USD 20,000 at the end of the first and second year and to USD 30,000 at the end of the third, fourth, and fifth year. The required rate of return for the project is 4.4%.
Question 1. Help the team of financial managers to evaluate the project using the NPV method to make the right investment decision.
Expert Solution
As per this case study the Amazing Integration Ltd was preparing to invest into several projects to increase its company’s value as well as to expand its market share and to integrate the new technology. And the CFO suggested that Project that has high NPV will meet the investor requirement in terms of both increase of owners' equity and as well as the stock price.
Let’s workout and conclude whether this project will provide positive NPV in order to increase the owner’s equity and as well as stock price
NPV calculation:
To arrive the net present value, we have to multiply the future value with the discounting factor
Formula to calculate the discounting factor= 1(1+r) ^n, in this r is discounting interest rate and n is number of years
The initial payment does not require to be multiplied by the discount factor since it is made on the same day (present day)
Required rate or the disciunt rate is 4.4%
So the discount factor would for 1st year = 1/(1+.044)^1= 0.694444444 and in the same way we have to calculate for all the years
So, the calculation will be looks like
|
Year |
Cash inflow /Out flow |
Discounting factor |
NPV=cash flow* DF |
|
0 |
-100000 |
1 |
-100000 |
|
1 |
20000 |
0.95785441 |
19157.0881 |
|
2 |
20000 |
0.91748506 |
18349.7013 |
|
3 |
30000 |
0.87881711 |
26364.5133 |
|
4 |
30000 |
0.84177884 |
25253.3652 |
|
5 |
30000 |
0.80630157 |
24189.0472 |
|
|
|
NPV |
13313.7151 |
So when the NPV if it is positive then it is a worth investment based on time value of money, if it is negative then it is not worthy investment
So this is better to go with this investment to fulfil all the investors obligations
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