This memo is being prepared to analyse the acceptableness of the new production installation for company at different hurdle rates and the deductions of accepting the same on company net incomes. hard currency flow and part to return on equity. This will beef up the justification why this undertaking was chosen as against other options. This undertaking has positive net nowadays value ( NPV ) at different rates of 10. 15 % and 18 % . which makes it acceptable.
Positive NPV in finance theory means that at cost of capital. the present values of hard currency escape and escapes will be good to the company as it will increase the company hard currency place and net incomes ( Brigham and Houston. 2002 ) . To exemplify if the NPV of $ 1. 291. 659. 16. if is assumed to be most accurate value based on cost of capital at 10 % . so said sum is efficaciously an addition in hard currency under the balance sheet of the same sum and addition in income under the income statement. See Appendix A.
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Increasing hard currency place improves every bit good liquidity place of the company. Liquidity place is measured by speedy ratio and current ratio. In both instances. increasing hard currency. which is portion of speedy assets or current assets. by certain sums without matching addition in current liability will decidedly increase the said liquidness ratios and could beef up the company’s place against possible bankruptcy. It must be noted that calculations in Appendix A treated as hard currency outflows the undermentioned: rental or lease disbursal of $ 1.
5 million a twelvemonth. other disbursals of $ 100. 000 per twelvemonth as hard currency escapes. undertaking cost of $ 4 million and the corresponding revenue enhancements. while the hard currency influxs include the annual grosss and the depreciation which was added back because it does non imply a hard currency escape when deducted as portion of operating disbursals for revenue enhancement intents. In consequence. the depreciation provided a revenue enhancement shield for the undertaking. In footings of its impact of return to equity ( ROE ) . the same will besides increase the said rate even presuming that the $ 4. 000. 000 initial hard currency escape at twelvemonth 0 was financed by equity.
If is assumed that company has a present equity of $ 100 million and the undertaking cost of $ 4. 000. 000 was financed through equity or extra investing from proprietors. its 2003 income statement at $ 29. 4 million. presuming the same degree of income. will be attained when the production installation is implemented. would increase to $ 30. 69 million. If the same sum is divided by new equity of $ 104 million. this could increase the ROE to 29. 51 % from 29. 4 % before the undertaking.
It is hence recommended that the undertaking of new production installation should be accepted by the company because the undertaking has positive NPV and its MIRR of 18 % is greater than cost of capital of 10 % . See Appendix A. Recommendation is farther based on addition in the hard currency place of the company. increase net net incomes and increased return on equity that could foster attract investors by perchance increasing the stock monetary value of the company. Appendix A- See Excel File Mentions: Brigham and Houston ( 2002 ) Introduction to Financial Management. Thomson-South Western. USA. Case study- given with income statement