The paper "Investment Appraisal of Elgar Pharmaceutical Ltds Proposed Investment" is an outstanding example of a finance and accounting assignment. Net present value (NPV) is a superior investment appraisal tool. It seeks to measure by how much an investment increases the shareholder’ s wealth in absolute value and in today’ s terms (Dobson, 1997). It incorporates the all-important concept of the time value of money. This concept appreciates that a dollar received today is worth more than a dollar received tomorrow. This concept is incorporated in the net present value calculation by a process called discounting; this is done by multiplying future values by a discounting factor based on the discount rate (Dobson, 1997). The discount rate represents the cost of capital.
In the case study of Elgar Pharmaceutical Ltd, the discount rate is 12%. This was arrived at based on the assumption that the tax rate is 20% per annum and that the bank’ s interest rate of 15% is the pre-tax cost of debt. Since interest on bank loans is tax allowable, then a post-tax cost of debt must be calculated.
This is done by multiplying the interest rate by, one minus the tax rate (interest rate * (1-interest rate) giving a rate of 12%. From the discount rate, a discount % is calculated, by adding one to the discount rate then raised to the power of time in years. In this case (1+12%) ^-1, this gives an annuity factor of 0.893 (rounded off). This figure can be obtained directly from the present value table in the column with12% and the row with year one. For the purpose of analyzing Elgar Pharmaceutical Ltd’ s investment, it is assumed that the post-tax cost of debt is equal to the company’ s weighted average cost of capital and thus it is an appropriate discount rate.
It is assumed that the whole of the initial capital outlay is to be incurred now/time zero. This eliminates the need to discount the $ 400,000 cash outflow. It is normal for capital investments to attract capital allowances in terms of tax benefits but this has been ignored in this analysis.
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