Capital Appraisal Research Paper Example | Topics and Well Written Essays - 1500 words

Capital Appraisal - Research Paper Example Total Cost 14,000,000 22,400,000 28,000,000 19,600,000 9,800,000 Gross Profit (Rev-cost) 10,000,000 8,400,000 11,600,000 6,800,000 200,000 Less: Depreciation Expense (1,600,000) (1,600,000) (1,600,000) (1,600,000) (1,600,000) Net Profit/Net Loss 8,400,000 6,800,000 10,000,000 52,000,000 (1,400,000) Calculation of Cash Flow Years 2008 2009 2010 2011 2012 Net Income/Net Loss 8,400,000 6,800,000 10,000,000 52,000,000 (1,400,000) Add: Depreciation expense 1,600,000 1,600,000 1,600,000 1,600,000 1,600,000 Cash Flow 10,000,000 8,400,000 11,600,000 6,800,000 200,000 Present Value of Future Cash flows Years 2008 2009 2010 2011 2012 Interest factor 0.621 0.683 0.751 0.826 0.909 Cash Flow 10,000,000 8,400,000 11,600,000 6,800,000 200,000 Present Value 6,210,000 5,737,200 8,711,600 5,616,800 181,800 Present Value of Terminal Cash Flow $ Present Value Interest factor 0.621 Salvage Value + Working Capital 4,000,000 Present Value of Terminal Cash Flow 2,484,000 Calculation of Net Present Value $ Present Value of Cash Flows 26,457,400 Present Value of Terminal Cash Flow 2,484,000 Total Cash Flow 28,941,400 Less: Initial Investment (17,050,000) Net Present Value 11,891,400 Option 2 Initial Investment (Cash Outflow) $ Research & Development Expenditure 5,000,000 Since the manufacturing and marketing has been outsourced by Newton to another company Faraday Electricals Ltd, Newton does not have to bear any fixed or variable costs. Calculation of Income Years 2008 2009 2010 2011 2012 Royalty Payment (No. of Units) 880,000 1,540,000 1,980,000 1,320,000 550,000 x Royalty Payment/unit 5 5 5 5 5 Total Income 4,400,000 7,700,000 9,900,000 6,600,000 2,750,000 The income is the cash flow that will be discounted at the present value factors as... 1. Newton has three options with respect to the operation of the business. The first option is to manufacture market and sell the products itself; the second option is to outsource the entire manufacturing and marketing of the products to another company Faraday Electricals Ltd and receive royalty payments and the third option is to sell the patent rights to Faraday Electricals Ltd and receive the money from it. 2. There are many factors that should be taken into account besides the calculation of Net Present Value (NPV) before making a decision. If the payback period is calculated for option 1, it is 1.83 years which means that the initial investment is recovered in less than 2 years. Payback period for option 2 is 2.5 years and payback period for option 3 is 2.42 years. The payback period suggests that Newton should consider option 1 as it has the lowest payback period. However, payback period has its flaws which make it a less reliable method in making decisions. Firstly the payback method ignores all the cash flows that are generated after the payback period and secondly it gives equal weights to all the cash flows before the payback period despite the fact that the more distant cash flows are less valuable. IRR for option 1 is 42%, IRR for option 2 is 25% and IRR for option 3 is 26%.