NPV Introduction Budget analysis techniques are very important particularly when evaluating the need to proceed with a project or not
NPV Introduction Budget analysis techniques are very important particularly when evaluating the need to proceed with a project or not. Some of the technique used are the IRR, where the investors would note the interest return rate of their project. Secondly, the net present value is useful when noting down the value of an investment at the present moment. This requires that the future cash inflows be converted back into present value. Others include the payback period, which is important for investors who have set the time limits for their investments plans. Therefore, this exercise aims at evaluating the evaluation techniques to note their importance when making decisions on whether to invest on a project or not. The three techniques are used in assessing the importance of analyzing the business before investing on it. Thus, critical decisions are therefore made in the end. Calculation and Discussion The project NPV is calculate using the formula NPV (Cash inflow for year 1/(1R)1 (Cash Inflows for year 2/(1R)2 . (Investopedia.com, 2018) Therefore, the NPV would be calculated using the cash flows for the 10 year period. 600000/(10.13) 1000000/(10.13)2 1000000/(10.13)3 2000000/(10.13)4 3000000/(1.13)5 3,50000/(1.13)6 4000000/(1.13)7 6000000/(1.13)8 8000000/ (1.13) 9 12,000000/(1.13)10 530,973 787, 401 694,444.44 1,1834311630404 1,741,912 The net present value is obtained by subtracting the present value of the cash flow accumulated for the next 10 years to the initial investment. The initial investment is given as 15 million dollars which implies that the value is supposed to be positive if the investment is showing good results. Meanwhile, a negative NPV shows that the investment is not worth the risk. The rate given at 13 reflects the ability of the business to generate income. Based on the calculation of the project NPV was obtained from the subtraction of the net cash inflows minus the investment That is 21,246,000 -15,000,000 the resultant value is 6,246,000. This is a positive value which implies that the NPV is a profit. Therefore the project is worth investing on and is acceptable. It is acceptable under the NPV technique. The only unacceptable project are the ones which do not have their NPV exceeding below the 0 mark. Meanwhile, the project internal rate of return is calculated using the following formula. NPV the sum of Cash inflows/ (1R)t. (Investopedia.com, 2018). Where t is the time or period which for this case is yearly. However, the IRR is determined by setting the NPV value to be 0 instead of the one obtained at the first case. Hence, the IRR would be calculated using the new formula as 0the sum C/(1R)t – I. where C the cash flows which is expected in every year of operation. The value R is the discount rate. It becomes IRR when the value of NPV is set to 0. From the projects evaluation techniques, the best way to select the best project is through the IRR. Large IRR implies that the project return rate is worth the investment. From the calculation using the formula of IRR, the value is found to be 14.45. The value is higher compared to the 13 set for the project investment (Investopedia.com, 2018). According to the project report, the IRR technique is acceptable since it give a higher value compared to the discounted rate. The IRR technique only allows the projects whose rate of return are less than the discounted rates. Therefore, the project can be affirmatively said that it is just and acceptable based on the IRR. In both the results, that is the NPV and IRR, the project seemed acceptable based on the reports produced. The NPV of the project gave a positive result. Hence, both of the projects are acceptable. Meanwhile, both techniques cannot be used to evaluate the projects acceptability. One measure is always used in preference to the other. The NPV is easily predictable based on the discounted rate provided. Meanwhile the IRR cannot be used since any project is likely to contain many discount rates. It would be inappropriate to use one discount rate over ten year when the market demands are always fluctuating unpredictably. The NPV is appropriate and mostly preferred since it can be used to evaluate many projects based on its flexible nature of accepting multiple discount rates. Over the 10 year period, the preferred way of evaluating a project is using the NPV since it can accommodate the multiple discount rates. In the event that the market environment changes such that the IRR is different, the calculation of the NPV would not be affected (Investopedia.com, 2018). That is, in the event that the rate changes on yearly basis, the NPV still uses the same formula to calculate. Meanwhile, the IRR. In order to calculate the payback period, it would be necessary to note the amount of time it would take for the project to return its investments. The invested amount is 15 million dollars. Therefore, the year through which the investment money is obtained back is the payback period. Based on the table of cash flow given, the following table is generated to reflect on the present value of the cash inflows expected over the 10 year period. The first 12345678910530,973787,901694,4441,183,4311,630,4341,741,2931,702,1272,077,9222,012,982 Calculating the whole net present values for the period of 10 years would yield a net value of 21 million. However, the year through which the 15 million is recovered in the 9th year of investment. According to the firms policies, the payback period should lie between the 1st and 7th year. This implies that the project would not be viable based on the year of set by the firm. Therefore, the project is not acceptable due to the failure to meet the payback period. At the 9th years the firm is likely to have lost its patient on following its investment period. Payback period is one of the measures that is useful in evaluating the feasibility of the project. Conclusion After the successful completion of the calculations process, the decision was made to finally abandon the project. The first phase involved assessing through the NPV where it passed. The second phase involve passing it through the IRR technique where it also passed. The third phase failed after failing to pass through the payback period technique. Therefore, the project was not feasible according to the demands of the investors themselves. In addition, the comparison between the IRR and the NPV are very useful where the NPV is preferred over IRR due to its flexibility. Through NPV people can perform multiple discount rates. Therefore, the evaluation techniques are very important in decision making. References Investopedia.com (2018). Net Present Value (NPV). Retrieved from https//www.investopedia.com/terms/n/npv.asp Investopedia.com (2018). Internal Rate of return. Retrieved from https//www.investopedia.com/terms/i/irr.asp Investopedia.com (2018). Payback period. Retrieved from https//www.investopedia.com/terms/p/paybackperiod.asp EPS Introduction The Encore firm is an example of the business that performs but requires some intervention in assessing its potentiality. One of the reasons that requires the analysis of the businesses based on the success history to predict its future. The P/E ratio are particularly used in noting the position of the business in terms of share value ratio. In addition, the parameters such as the return rate, the book value, stock value are discussed to assess their importance in the prediction of the business performance. The Encore presents very clear programs following its success of making up to 300 million dollars net worth. The business dreams to have their assets expanded and check the stability in the market. The analysis begins with noting the relevant ratios that help in determining the position of the business. Meanwhile, the company assess the relevance of return rate in its business performance. The Calculation and Review 1. The current book value per share is calculated using the formula below Book value per share book value of common stock equity/ the total common shares outstanding (Investopeida.com, 2018). The book value is estimated at 60,000,000 whereas the dividends per share is 2,500,000 Therefore it becomes 60,000,000/2,500,000 24. This value also represents the stock value of Encore which the company aims at increasing the value. 2. The firms current P/E ratio is calculated using the formula (Investopeida.com, 2018) P/E price per share of the common stock/earning per share This becomes 40/6.25 6.4 3. The current required return for the Encore stocks. Based on the Gordons model, it is easy to find the return rate using the divided discount model (Investopeida.com, 2018) That is k (D/S) g. Where the value k represent the required return The symbol d denotes the expected dividend payment in the coming year. The symbol g denotes the rate through which the dividend are growing. And finally s denoted as the stock value. Caution must be taken when using the new common stock since the floatation would be taken into consideration. Therefore, the required return is calculated using the above formula. D dividend payment which is 4 according to the data provided. The dividend has to be assumed that it is constant in order to make the calculation possible and feasible. Otherwise, the whole calculation would not work according to the expectation of the firm or investor. S is the stock value that is currently being depicted by the firm actions. According to the data presented the book value per share is 24. Therefore, the current value (4/24) 6. The growth rate is estimated at 6. Thus, the required rate 0.6 6 6.4 4.1 The new required return for the firm would be calculated by considering floatation gross. Instead of using 6 as the floatation gross, the value of 8 can be used based on the financial analyst report. According to the report given, the annual growth of the dividends is given as 6, whereas the immediate 2 years to come, it is projected at 8 which will be succeeded by another growth of 6. Therefore, the return rate would be calculated as RR dividend payment/stock value dividend growth of the new investment The dividend payment is constant at 4 similarly the stock value is also constant at 24. The new rate will be calculated using 8 Hence the return rate is calculated as RR 4/248 8.6 for the first 2 years then again back to the normal 6.6 of the current return rate. 4.2 The new value per share would be calculated using the new standard required return. Because there is no future growth likely to be experienced, the same value of return rate of 6.6 would be used in the set up. The current stock value of Encore is 24. Hence, increasing the stock value by 6.6 That is 106.6/100 24 25.44 Therefore, the stock value of the firm would be 25.44. Had it been that the future value of dividend per share increased by 8, then the value would have increased but temporarily since it would only last for two years. The Gordon model of finding the return rate is very useful since it simplifies the calculation of parameters. Conclusion The Encore is an over performing business, however its superbly increased knowledge makes the demand of their products high. Thus, the evaluation came up with the results set as follows, the stock value being 24. The P/E was 2.4 which implies that the earnings per share was improving. Meanwhile, the return rate for the current price market and business performance was 6.6 which is used to assess the growth of dividend per share. It is constant in that the future of the company has been described and identified. Meanwhile, the exercise was performed well such that results depict the clear reflection of what is on the field. Also, the return rate was also important in assessing the performance of the business in the future. References Investopeida.com 2018. P/E ratio. Retrieved from https//wwww.inmvestopeisa.co/univerisity/peratio1.asp Investopedia.com 2018. Rate of Return. Retrieved from https//www.investopedia.com/terms/r/rateofreturn.asp PAGE PAGE 3 FINANCE Running head FINANCE1 Y, 4IsNXp
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