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Calculating cash flow and net present value (see paper for details) - Assignment Example

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Capital outflows refer to those cash outflows incurred on the acquisition of non-current assets, including any subsequent cash outflows borne in order to bring such assets into their present location and condition (Porter & Norton, 2008). These outflows are of a one-off kind and…
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CALCULATING CASH FLOW AND NET PRESENT VALUE Question a Capital outflows refer to those cash outflows incurred on the acquisition of non-current assets, including any subsequent cash outflows borne in order to bring such assets into their present location and condition (Porter & Norton, 2008). These outflows are of a one-off kind and their benefits are derived over several accounting periods. Such costs as presented in the case of this manufacturing organization is the acquisition of the new machinery at a cost of £300K, removal of the old machinery at a cost of £30K and the installation cost of £60K. On the other hand, revenue outflows are those cash outflows incurred so as to maintain the earning capacity of assets (Clarke, 2002). From the presented case of the manufacturing organization, revenue outflows are the additional support costs of £4K every year. Capital inflows refer to those incomes that are generated from other activities other than the normal trading of an entity. In the case of the manufacturing organization such capital inflows is the sale of machinery. On the other hand, revenue inflows are those incomes that are generated by an entity from its normal operations by selling goods or services.
Question b
Year 1
Year 2
Year 3
Year 4
Year 5
Cash inflows
80
80
81
91
91
Cash outflows
8
8
8
8
8
Net cash flows
72
72
73
83
83
Cumulative cash flows
72
144
217
300
383
To establish the payback period, the cumulative cash flows was established, but from the above calculations, the manufacturing organization could not cover its initial investment costs of £410K from the net cash flows it generates within a period of five years.
Question c
Year
Cash flows
Discount factor
Present values
1
72
0.91
65.52
2
72
0.83
59.76
3
73
0.75
54.75
4
83
0.68
56.44
5
83
0.62
51.46
∑PVs =287.93
NPV = present value - initial capital outlay
NPV= ∑287.93 - 410
NPV = (122.07)

Question d
Calculation of the Internal Rate of Return (IRR)
It is also a discounted cash flow technique that uses the principle of NPV. It is individual investment’s rate of return when it is considered in isolation or independently of all other investments that the firm undertakes. It is that rate of return which is inherent or internal to the cash flow of a given project. It is the discounting or required rate of return that gives a zero NPV i.e. ∑PVs – I0 = 0 NPV. Internal rate of return is established through trial and error, interpolation, or extrapolation method. Through the trial and error, a rate of interest is selected at random and is used in the establishment of NPV of the cash flows. If the rate chosen gives a lower NPV than the cost, a lower rate is chosen and if the rate gives a greater NPV, a higher rate is chosen. The process continues until the final rate chosen gives a zero NPV.
References
Clarke, P.J., 2002. Accounting Information for Managers. Illustrated ed. Hampshire: Cengage Learning EMEA.
Porter, G. & Norton, C., 2008. Financial Accounting: The Impact on Decision Makers. 6th ed. Boston, Massachusetts: Cengage Learning. Read More
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