Dissusion 1 to 3
Student 1
Jon Smedly’s has an opportunity to enhance their offering with the investment of a Knyttan, in partnership with Unmade. This cost associated with this investment is significant, and prior to moving forward we should understand if it is the right area to place our money in. When evaluating the viability of a project Net Present Value (NPV), internal rate of return (IRR) and/ or Payback Period are all options that can help support the decision (Brealey et al., 2020).
A positive NPV should be required when determining if a project should be selected. The IRR and payback period are not as clear cut and can be evaluated based on choosing the highest possible values (Excelsior College, 2022). The IRR provides an organization with a way to assess if the yearly growth rate of the investment is supposed to generate additional inflows in excess to generate a positive return. The payback period is determined by the number of years it takes to recover the initial funds invested (Kagan, 2022). The combination of the three calculations will provide a more financially sound justification for making an investment versus only using one. The acceptable payback period may vary depending upon an organizations tolerance to see a return.
At interest rates of 8% and 18%, analyze project finances using Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Criteria as these may be used to determine the acceptability of the proposed project, under the assumption that the project is standalone and will not draw resources from other areas of the firm. Include analysis of all components of project cash flow.
When considering the possibility that interest rates may rise from 8% to 18% we see that the NPV become negative (115,908) at 18%. This indicates that the project should not be undertaken because it will result in more cash outflows than inflows. The IRR and the payback period also would indicate the project should not be pursued at an 18% interest rate versus the 8%. If the interest rate could be locked in at 8% the project viability of the project is strong given the positive NPV, higher IRR and realistic payback period.
Recalling that (EBIT + Depreciation - Interest - Taxes) = Operating Cash Flow, evaluate the role of net working capital, depreciation and taxation in determining project cash flows.
Cash flows, depreciation, working capital and interest are all areas that need to be considered when determining if a project is viable. Net Working Capital (NWC) is the measurement between a company’s current assets and its current liabilities. The firm’s liquidity is measured by NWC and can be used to assess short-term financial health. Depreciation is a type of expense used to reduce the carrying value of an asset and affects cash flow because it is entered as a debit on the income statement (Parker, 2021). Taxes also directly impact the overall cash flow. Depreciation and taxes adjust the net income which is necessary in order to fully understand a realistic financial picture. Working Capital reduces operating cash flow and as a result NPV is also reduced.
As we finalize our assessment we need to consider the financial tools we have available to understand the risk and reward that can come from the capital investment of the Knyttan. Upon initial review the project would look to be successful at an 8% interest rate, while it would be not be favorable at 18%.
References
Brealey, R. A., Myers, S. C., & Marcus, A. J. (2020). Fundamentals of Corporate Finance. McGraw Hill Education.
Excelsior College Module 6. (2022). Module Notes: Project Analysis and Incremental Cash Flows. Retrieved from https://excelsior.instructure.com/courses/28284/pages/module-6-module-notes-project-analysis-and-incremental-cash-flows?module_item_id=2462438
Kagan, J. (2022, March 11). What is the payback period? Investopedia. Retrieved April 13, 2022, from
Student 2
Class,
Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time(Fernando, 2021). The NPV for 8% is $21,093 and for 18% is ($115,908). This indicates that at an 8% interest rate the project is profitable while at an 18% interest rate, the project will not be profitable.
The internal rate of return (IRR) is a metric used in financial analysis to estimate the profitability of potential investments. IRR is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis (Fernando, 2022). The Internal Rate of Return of 8% is higher at 30%, while the 18% return rate is at 20%. The IRR being higher with 8% shows that this would be more profitable.
The payback period refers to the amount of time it takes to recover the cost of an investment(Kagan, 2022). This is usually referred to as the break-even point. The 8% investment has a longer payback period of 3.2 years compared to the 18% investments payback period of 3 years. While the payback period timeline might seem trivial, for a business this can be a significant change in cash flow.
Working capital, also known as networking capital (NWC), is the difference between a company’s current assets—such as cash, accounts receivable/customers’ unpaid bills, and inventories of raw materials and finished goods—and its current liabilities, such as accounts payable and debts(Fernando, 2022). All these areas can drastically change the profitability of any project that is taken on. Depreciation is an area that can have a big change in cash flow as this can lower the tax implication for a company and save money in the 7-year time frame they are planning to pay it back.
Investopedia. (n.d.). Investopedia. Retrieved April 16, 2022, from https://www.investopedia.com/
Ross, S. A., Westerfield, R., & Jordan, B. D. (2021). Fundamentals of Corporate Finance. McGraw Hill.