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Financial Management by Timothy Gallagher and Joseph D Andrewsenior in college - Essay Example

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To find the NPV for the project and its payback period I have constructed the schedule of the incremental discounted cash flows for each of the nine subsequent periods from the period 0 when investment decision is made and initial capital outlay takes place to the period 8 (see Table 1 below).
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Financial Management by Timothy Gallagher and Joseph D Andrewsenior in college
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Financial Management by Timothy Gallagher and Joseph D Andrew: NPV and Payback Period To find the NPV for the project and its payback period I have constructed the schedule of the incremental discounted cash flows for each of the nine subsequent periods from the period 0 when investment decision is made and initial capital outlay takes place to the period 8 (see Table 1 below).
Taking into account the absence of inflation all the cash flows calculated can be considered both nominal and real flows. All the cash flows accounted for are of incremental nature. For discounting a project's cash flows MCC value of 10% has been used. Given then Superior Company will use for the new plant straight-line depreciation over the five-year period, the annual depreciation will be at $200,000 level for the first 5 years and equal to 0 over the following years.
Table 1. Incremental cash flows schedule
Discounting the cash flows for each of the periods and summing them up, I determined that the NPV of launching a new product is equal to $1,000,570. The value is positive and quite significant, therefore, based on the NPV criteria the project should be accepted and the new product launched.
However, if the company considers several mutually exclusive projects (for example, launching this product or investing instead in the new factory to increase the production of highly-demanded existing product etc.) and the NPV of this particular project is lower than of those also under consideration, it would be abandoned.
The initial investment is equal to $1,000,000. The sum of the discounted cash flows for the first three years amounts to $807,801 < $1,000,000. The sum of the discounted cash flows for the first four years is equal to $1,119,768 > $1,000,000. Therefore, the payback period is 3.62 years. Based on the Superior Company's policy of not accepting projects with life of over three years, the project of launching the new product under consideration should not be accepted.
If the project required additional investment in land and building, it would increase the initial capital investment amount and consequently decrease the NPV of the project. This effect would be partly offset by the tax shield because of depreciation of building, and difference between salvage and book values of land and building if sold afterwards. Read More
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