Investment Appraisal

Investment Appraisal

Part B-Section II

a)

Outflow

Inflow

Net Cash Flow

Year 0

250000

-250000

Year 1

180000

210000

30000

Year 2

183150

210000

26850

Year 3

186376

210000

23624

Year 4

189682

230000

40318

Discount Rate

12%

NPV

-£142,296.17

Project should not be chosen as the NPV of this project is negative. As per the calculations attached in excel sheet, we can easily say that this project is not suitable one for Alpha Products Plc. We have analyzed the given cash flows of the project using Net Present Value (NPV). The reason for analyzing this project by NPV is to increase the reliability and authenticity of our forecast. From the following table, we can easily see that Net Present Value of Project negative. We will reject the project because this would result in loss to Alpha Products Plc.

An approach used in capital budgeting where the present value of cash inflows is subtracted by the present value of cash outflows. NPV is used to analyze the profitability of an investment or project. NPV compares the value of a dollar today versus the value of that same dollar in the future, after taking inflation and return into account. If the NPV of a prospective project is positive, then it should be accepted. However, if it is negative, then the project probably should be rejected because cash flows are negative.

From the calculated value of NPV, we can say that the project has a positive return as NPV is positive. The project would result in increasing the profitability of the company according to the NPV results. The Net Present Value (NPV) is the first Discounted Cash Flow (NPV) technique covered here. It relies on the concept of opportunity cost to place a value on cash inflows arising from capital investment.

Remember that opportunity cost is the calculation of what is sacrificed or foregone as a result of a particular decision. It is also referred to as the 'real' cost of taking some action. We can look at the concept of present value as being the cash equivalent now of a sum receivable at a later date. So how does the opportunity cost affect revenues that we can expect to receive later? Well, imagine what a business could do now with the cash sums it must wait some time to receive.

In fact, if you receive cash you are quite likely to save it and put it in the bank. So what a business sacrifices by having to wait for the cash inflows is the interest lost on the sum that would have been saved.

Looked at another way, it is likely that the business will have borrowed the capital to invest in the project. So, what it foregoes by having to wait for the revenues arising from the investment is the interest paid on the borrowed capital. NPV is a technique where cash inflows expected in future years are discounted back to their present value. This is calculated by using a discount rate equivalent to the interest that would have been received on the sums, had the inflows been saved, or the interest that has to be paid by the firm on funds ...