Perform The Final NPV Calculations And Provide A Narrative
Perform the final NPV calculations and provide a narrative on how you calculated the computations and why
The following are the values to the data: The cost of the equipment will be $70,000 and this cost is incurred prior to any cash is received by the project. The expected annual cash revenue of the project will be $30,000. The expected annual cash outflows (expenses/costs) are estimated at being $11,000, excluding depreciation. Your tax rate is 30% and you plan to depreciate the equipment on a straight-line basis for the life of the equipment. The discount rate you are assuming is 6%. After 5 years the equipment will stop working and there will be no salvage value.
Perform the final NPV calculations and provide a narrative on how you calculated the computations and why (justification of answer). Present your calculated answers in schedule format (a table) along with your narrative. Microsoft Excel is also recommended for calculating and creating a table (your schedule). Then provide a summary conclusion on whether you should continue to pursue this business opportunity.
Research, using at least one other source other than the textbook materials that support your calculations and conclusions. Papers will be assessed on the following criteria: Provide the final, accurate NPV calculations. A narrative on how the NPVs were calculated. The narrative should include how the data relating to depreciation and its tax consequences affect the cash flow of the project. Include a table with your analysis to present your work. Provide a conclusion on whether this business opportunity should be pursued.
Paper For Above instruction
Perform the final NPV calculations and provide a narrative on how you calculated the computations and why
This paper presents a comprehensive analysis of the net present value (NPV) for a proposed investment in equipment, utilizing relevant financial data and applying standard capital budgeting techniques. The goal is to determine whether the project is financially viable and worth pursuing based on the calculated NPV, considering depreciation, tax effects, and discount rates.
Financial Data and Assumptions
- Initial cost of equipment: $70,000 (incurred prior to cash inflow)
- Annual revenue: $30,000
- Annual operating expenses (excluding depreciation): $11,000
- Tax rate: 30%
- Depreciation method: Straight-line over 5 years
- Salvage value at end of 5 years: $0
- Discount rate: 6%
Methodology and Calculation Approach
The analysis involves calculating annual cash flows considering revenues, operating expenses, depreciation, and taxes. Since depreciation is a non-cash expense, it affects taxes but does not impact actual cash flows. To compute the NPV, we first determine the after-tax cash flows, incorporate tax shield from depreciation, and discount these cash flows over the project’s lifespan.
Depreciation Calculation
Depreciation per year = Cost of equipment / Useful life = $70,000 / 5 = $14,000
Tax Shield from Depreciation
Tax savings due to depreciation = Depreciation x Tax rate = $14,000 x 0.30 = $4,200 annually
Annual Operating Cash Flows
Before-tax operating profit = Revenue - Operating Expenses - Depreciation = $30,000 - $11,000 - $14,000 = $5,000
Taxes on operating profit = Operating profit x Tax rate = $5,000 x 0.30 = $1,500
Net operating profit after taxes = Operating profit - Taxes = $5,000 - $1,500 = $3,500
Adding back depreciation (non-cash expense) yields the operating cash flow:
Operating cash flow = Net profit after taxes + Depreciation = $3,500 + $14,000 = $17,500
NPV Calculation
| Year | Operating Cash Flow | Discount Factor (6%) | Present Value (PV) |
|---|---|---|---|
| 1 | $17,500 | 0.9434 | $16,510.45 |
| 2 | $17,500 | 0.8900 | $15,615.00 |
| 3 | $17,500 | 0.8396 | $14,693.00 |
| 4 | $17,500 | 0.7921 | $13,872.00 |
| 5 | $17,500 | 0.7473 | $13,102.00 |
Initial Investment (cash outflow): $70,000
NPV Computation
NPV = Sum of discounted cash flows - Initial Investment = (Sum PVs) - $70,000
Sum of PVs = $16,510.45 + $15,615 + $14,693 + $13,872 + $13,102 = $73,792.90
NPV = $73,792.90 - $70,000 = $3,792.90
Justification and Impact of Depreciation on Cash Flow
The depreciation expense reduces taxable income, resulting in tax savings (tax shield), which effectively increases net cash flows. Incorporating depreciation's tax effect is essential in accurately evaluating the project's cash flow and profitability. The depreciation expense does not cash outflow but affects taxable income, decreasing taxes paid, thereby enhancing cash flows. This analysis confirms that the project provides a positive NPV, supporting its financial viability.
Conclusion
Based on the analysis, the project's positive NPV of approximately $3,793 suggests it is a worthwhile investment. Considering the cash flows, tax implications of depreciation, and the discount rate, pursuing this business opportunity appears justified. It is recommended to proceed with the investment, keeping in mind potential risks and market conditions.
References
- Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
- Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice (15th ed.). Cengage Learning.
- Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset (3rd ed.). Wiley.
- Asian Development Bank. (2018). Impact of Depreciation Methods on Investment Appraisals. Retrieved from https://www.adb.org
- Investopedia. (2023). Net Present Value (NPV). Retrieved from https://www.investopedia.com