Unit 3 IP



Project Capitalization & Investment

Introduction

Investments are one of the most essential long term decisions for companies. Capital budgeting has been termed as one of the most important phase which evaluates the level of expected return and level of the cost or expenditure of the project over the defined period. Project Capitalization & Investment analysis is the fundamentally important due to their attractive features that assist management and investors for making effective and better decisions. In this paper, the focus would be on Project Capitalization & Investment analysis of Klottier & Walson, Inc.

Discussion

Part 1

What is the cash flow projection for this equipment, annually, for the next 5 years?

 

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

 

 

Initial Investment

(150,000)

 

 

 

Additional cost to Investment

 

Utilities Expense 1,000 1,000 1,000 1,000 1,000

Warranty Expense

6,000 6,000 6,000 6,000 6,000

New Employee Salary 36,000 36,000 36,000 36,000 36,000

20% on Salary

 

7,200 7,200 7,200 7,200 7,200

Total Cost

50,200 50,200 50,200 50,200 50,200

 

 

Revenue

75,000 75,000 75,000 75,000 75,000

 

 

Net Revenue

24,800 24,800 24,800 24,800 24,800

Add: Depreciation Expense

30,000 30,000 30,000 30,000 30,000

Cash flow projection (150,000)

54,800 54,800 54,800 54,800 54,800

The projected cash flow for this equipment would be $ 54,800 for next five years.

What is the NPV for this project?

NPV of the project has been calculated using the following formula (Northcott, 2012):

Net Present Value: Present Value of Future cash inflows and outflows - Initial investments

Present Value: Cashflow/ (1+i) ^n

NPV= ?CF/1+i) ^n - C0

Year

Cash flows

Discount Rate: 10%

Discounted cash flows

0

($ 150,000)

1

($ 150,000)

1

$ 54,800

0.909091

$ 49,818

2

$ 54,800

0.826446

$ 45,289

3

$ 54,800

0.751315

$ 41,172

4

$ 54,800

0.683013

$ 37,429

5

$ 54,800

0.620921

$ 34,026

Present Value of cash inflows

$ 207,735

Initial Investment

($ 150,000)

NPV

$ 57,735

NPV of the project is $ 57,735 and according to finance theory, NPV having positive value means that this project will add value to the company and hence, this project should be accepted, while NPV with negative value state that this project will subtract value from company and acceptance of the project should be rejected (Fisher, 2012).

In this case, since NPV is positive, this project should be taken into consideration as acceptance would add value to the company overall profitability (Frank, 2011).

What is the IRR for this project? IRR of the project has been calculated using following formula (Frank, Brown, 2012):

Positive value Rate * (Positive Value figure of NPV) + Rate Difference

Positive + negative value Figure of NPV

= 0.23+(3630/(3630+5598))*0.03

IRR of the project is 24% and according to finance theory, when IRR is greater than Cost of capital, project should be accepted. IRR is rate at which Net Present Value is zero, in order words; initial investment amount would be recovered (Cheng, 2011).

Part 2

What are the key factors that could be overestimated or underestimated in this project?

The factors that could be overestimated or underestimated in this project are as followed:

Utilities Expense can be understated since this is not so much essential part of the project. Beside this, previous project utilities expense was less than $ 1000, underestimating would not be impacting on the overall cash ...