Cash Flow and Net Present Value Essay

Submitted By ClydeKocher
Words: 1598
Pages: 7

(TCO 8) Planning for capital investments is an important function of management. You are responsible for considering purchasing a new exhibit. It would cost $136,000 and have an estimated useful life of 5 years. The salvage value is $70,000. It is expected to increase net annual cash flows by $25,000. The borrowing rate is 8%. The cost of capital is 10%. Calculate the net present value of this project. (1) Explain the pros and cons of using this method to evaluate a capital expenditure (10 points) and (2) show all computations required to arrive at the correct solution. (15 points). (Points : 25)

Net Present Value = -136000 + (25000/1.1) + (25000/(1.1^2)) + (25000/(1.1^3)) + (25000/(1.1^4)) + (25000/(1.1^5)) + (70000/(1.1^5)) = $2234.16

Pros – Net Present value considers time value of money and is easier to calculate than some other method such as IRR. NPV method gives firm the absolute value of gain as opposed to other measure, which may just give relative decision. It can be used when comparing different projects and enables better allocation of capital.

Cons- Determination of Cost of capital is very critical in successfully determining Net present value of project. If Cost of capital is calculated incorrectly or cannot be calculated at all, Net present value cannot be relied. Accurately determining Cash Inflow and outflow is a difficult task. It ignores benefits gained relative to the amount invested.

2. (TCO 6) To adequately plan for the success of the business a budget must be developed. (1) Identify the budgets that comprise the master budget (10 points) and (2) Describe the sources for preparing the budgeted income statement (15 points). Include textbook page references to identify where the correct answer was located. (Points : 25)

Master budget comprise of 1) Operating budgets a. Sales budget b. Production budget c. Direct materials budget d. Direct labor budget e. Manufacturing overhead budget f. Selling and administrative expense budget, and g. Budgeted income statement; and 2) Financial budgets h. Capital expenditure budget i. Cash budget, and j. Budgeted balance sheet

Sources for preparing the budgeted income statement (a) Sales budget, (b) Direct materials budget (c) Direct labor budget (d) Manufacturing overhead budget (e) Selling and administrative expense budget.

3. (TCO 4) Financial statement analysis is used by investors, creditors and managers of business to evaluate the operation and health of the business. This information is in part the basis for decision making. (1) Explain how to use the Statement of Cash Flows to understand the operation of the business (10 points) and (2) provide an example of how the results of this analysis could be used to make business decisions. (15 points). (Points : 25)

The Statement of cash flow is a very important financial statement ad it help to determine the source and uses of cash by the Business. It comprises of three sections namely cash flow from operations, cash flow from investing activities and cash flow from financing activities. Analysis of statement of cash flow helps to understand how the core business activities of company is managed, what is company main source of cash inflow and outflow, what activities is company involved in for investing or financing.

Cash flow from operating activities tell about cash inflows and outflows that occur during the normal course of business and business ability to convert it income into cash. So if the company is profitable but not able to convert those profit into cash it may be heading for trouble. On the other hand healthy cash inflow from operations shows strong business model.
Cash flow from investing activities shows the