Managing Financial Principles and Techniques - Essay Example

For this project the company has hired an international firm of management consultants who has forecasted the cost of production, selling price and profit per unit for mobile. They have also forecasted the demand for the new mobile in 5 year period down the line. The forecast made by them is as follows- Net Present value (NPV) is very common financial tool often used by the management to find out whether a new project will be beneficial in the future or not. NPV is the “difference between the present value of cash inflows and the present value of cash outflows” (Investopedia. 2009). The major advantage of this tool is that it takes time value of money into account, thus the result arrived at are more accurate as compared to simple pay back value.

But many people find if a bit complicated (Stoltz, A. & Viljoen, M. 2007). The company assumes that per unit fixed cost and interest per unit, both varies with the level of production. But other general costs like advertising expenditure and maintenance remain constant, irrespective to the level of production. As per the result derived from the analysis it is found that the NPV of the project is negative, hence the project should not be accepted. The company has an option that instead of setting the new production line, they can use the existing machine which is under utilized.

As per the company’s policy the machinery has to be depreciated along straight line method, so next year the written down value will become zero. Thus in the second year company has to purchase a new machine which will cost £500,000. Thus the NPV and the IRR of the project will be as follows- The NPV of the project comes positive which indicates that the project will have sufficient cash inflow and it will be profitable in the long term. Hence on the basis of NPV the project can be accepted.

The IRR of the project is 35%; which is above the cost of capital (10%). So this clearly indicates that the project should be