Finance analysis Essay Example | Topics and Well Written Essays - 1000 words

Finance analysis - Essay Example In this study, it was required to compute the Net Present Value of a project for a given company and make a recommendation on whether the project is worthwhile or not. The NPV of a project is the difference between the present values of its cash inflows and its cash outlays. The NPV technique makes use of the discounted cash flow method and discounts the cash flows at the rate of the cost of capital (Smart & Megginson, 2008, p. 261). Additionally, this paper includes designing a capital budgeting model that can be used to evaluated similar projects. Research on Model Design The conventional use of financial models is to evaluate the financial feasibility of a proposed investment. Such models can be utilized to investigate the various investment alternatives that are available, in order to choose the most viable one. Generally financial models are designed to assess a particular capital budgeting project. Capital budgeting choices are supposed to be based on cash flows, instead of acc ounting profits. Additionally it is the incremental cash flows that are applicable. In general, a project is undertaken if the NPV of the incremental cash flows generated from it is found to be positive. However, there may be instances when a Company has multiple projects to choose from but due to budget constraint, the firm’s management might not be able to select all the projects that have a positive NPV. In such cases, the projects having higher values of NPV are opted over those which have inferior NPV values. When the projects are mutually exclusive, the one having the highest NPV is chosen and the others rejected (Gallagher & Andrew, 2007, p. 270). It is known that spreadsheets are suitable and very useful device that are utilized in the assessment of capital projects. The most common methods used in these models are the NPV and the IRR, though other methods like payback period and accounting return are also used. The review of literature revealed that the most popular and publicly available capital budgeting models were the one created for assessing investments in forestry. Some of these models comprise of the FARMTREE model, Agro Forestry Estate model, Australian Farm Forestry Financial Model and the Australian Cabinet Timbers Financial Model (Dayananda et al, 2002, pp. 237-240). These models are designed to evaluate forestry investments and owing to their large scale and exclusive requirement are complicated in nature. On the other hand, the model prepared for the appraisal of the MP3 player project has been built according to its customized requirements and hence best suited. This model is user friendly and even a layman would be comfortable using it for appraising similar projects. The model has been so created, that even if the input variables and the associated relationships are changed, the model would be able to accommodate the changes. Capital Budgeting Model and the explanation of the Outputs For the calculation of the NPV of the new MP 3 player production project that is being considered by the Company, it is crucial to determine the cash flows related to the project. The cash flows can be grouped as follows: Initial capital outflow Operating cash flow during the project’s life (in this case: 5 years) Cash flow during the terminal year of the project The initial capital outflow of the company included the training cost, the retirement package, the working capital requirement and the equipment cost, i.e. $158,701,000. The components of the operating cash flows in the next five years have