Case Module 5: Case Net present Value, Mergers and acquisitions

Case Module 5: Case Net present Value, Mergers and Acquisitions

Part 1: Capital Budgeting Decisions

This part of the assignment relates to finding out the Net Present Value of a project that Micron technology wishes to undertake. Based on the analysis of the findings, it has to be advised to the company whether or not they should be undertaking and executing the project in future. This implies that the company will only undertake the project if in case the Net present value reflects gains to the company and ensure maximization of shareholders' wealth. The cash flow figures provided by Micron Technology for this part, is as follows:

Initial outlay

$-2,225,000

Year 1

$350,000

Year 2

$939,000

Year 3

$720,000

Year 4

$500,000

Year 5

$900,000

Cost of capital (discount rate) = 9%

The Net Present value of the company can be calculated using following steps in sequence:

Calculate present value (PV) of cash inflow (CF)

PV of CF = CF1 / (1+r) 1 + CF2 / (1+r) 2 + CF3 / (1+r) 3 + CF4 / (1+r) 4 + CF5 / (1+r) 5

Calculate NPV

NPV = Total PV of CF - Initial cash outflow

Or

-Initial cash outflow + Total PV of CF

r = Discount rate (9%)

Using the same sequence of steps, the NPV of the project was found to be:



It is important to describe the NPV decision rule here. Naturally the Net present value of all future projects must come in as a positive figure which shows that the project will add value to the firm, and will prove to be sustainable. Whenever an investment is associated with a positive NPV, it is not only convenient in terms of economic and financial gains, but is also the least expensive of the other investments with similar characteristics. Comparing the NPV of two or more alternative investments, a company can evaluate the most advantageous option through the mechanism of discounting of costs and revenues, which provides due to the same horizon of the cash flows that would manifest themselves at different times and therefore, is normally not directly comparable (Allman, 2010).

A negative NPV does not mean that there is a net yield, but it means that the return on investment is less than the alternative (i.e. those with the same risk). In fact, if we consider an investment of $1,000 at time 0 with a gain after 1 year of $1100 and use a rate of return of 20%, the NPV is negative (-83.33). This makes $83.33 (discounted) less than an investment alternative, which means that the company must possibly be looking forward to an alternative investment or project that could result in substantial gains. It is important then the choice of the rate to be applied serves to identify investments with similar characteristics (Reynolds et.al, 2012). This can be illustrated to the shareholders of Micron Technology as part of the meaning of the entire NPV concept. In this case, based on our calculations and findings, the decision that can be taken is that Micron Technology must accept the project since the ...