Assignment
Introduction: The assignment requires the application of the net present value (NPV) model to assess investment options given the cost of capital, commonly referred to as discount rates, and required rates of returns. You will explain the role of a discount rate in evaluating the NPV model and compare investment options as cost of capital increases or decreases. The use of a financial calculator and/or Excel will be required in this assignment.
Scenario: A new product manager presents to you, the chief financial officer, a proposal to expand operations that includes purchasing a new machine. The product manager is certain that the positive cash flows exceed the initial outlay by the end of Year 4. You explain the company uses a 13% discount rate for cash flows and project-related budgeting. You take the time to present the details of the net present value (NPV) model used to assess product proposals. The data is below.
Project Outflows to Buy Machine
Day 1 Cash Out $100,000
End Year 1 Cash Repayment $20,000
End Year 2 Cash Repayment $20,000
End Year 3 Cash Repayment $30,000
End Year 4 Cash Repayment $30,000
Discount rate 13.00%
To educate the new manager, and as CFO, you take the time to evaluate the following:
Task
• Explain how the time value of money concept results in a discounted cash flow in Year 4 (an amount less than $30,000).
• Assess the investment option using a 13% cost of capital discount rate by applying the NPV model. Provide the NPV at a 13% cost of capital discount rate. Include values in your assessment.
• Assess the investment option when an 8% cost of capital discount rate, versus a 13% cost of capital discount rate, is applied. Provide the NPV at an 8% cost of capital discount rate. Include values in your assessment.