Course Project: Al Thomas with the Recommendation Introduction The Watson Leisure Time Sporting Goods has enhanced its operations and is now thinking about the introduction of new equipment in his operations. Five year earnings before depreciation and taxes have been provided to us. The paper will calculate and analyze the net present value of the undertaking project and provide Al Thomas with the recommendation. Earnings after Taxes The depreciation and tax rate had been provided to us and we calculate the earnings after tax. The earnings show no consistent pattern and slump to a very low value of $1,664 in the second year only due to the high depreciation charge.
But the earnings show a steady growing pattern after the second year and up to the last year of the project. The EBDT is a forecasted value which represents the speculation of the company. Any simple change in the costs and sales would alter the project cash flows, NPV and IRR by a great extent. The tax rates remain consistent and therefore have the least impact. Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 EBDT $120,000 $105,000 $80,000 $65,000 $53,000 $45,000 Less: Depreciation 64,000 102,400 61,440 36,800 36,800 18,560 EBT 56,000 2,600 18,560 28,200 16,200 26,440 Less: Taxes* (@36%) 20,160 936 6,682 10,152 5,832 9,518 EAT $35,840 $1,664 $11,878 $18,048 $10,368 $16,922 Cash Inflows The cash flows are the most part of the company’s operations.
It represents the cycle of all the cash movements moving in and out of the company. Apparently, the company has made the highest cash inflows in the initial two years bur have then declined steadily over the next four years. The major slump came in the second year where the cash flow declined by 30%.
Therefore, it can be assumed that the company was not making enough cash from the project to cover the costs and expenses. Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 EAT $35,840 $1,664 11,878 18,048 10,368 16,922 Add: Depreciation 64,000 102,400 61,440 36,800 36,800 18,560 Cash Inflows 99,840 104,064 73,318 54,848 47,168 35,482 Present Values The time value of money is an important concept. $1 today is more valuable that $1 a year from now. Therefore, we need to bring all the cash inflows and outflows to an equivalent so that they can be compared. All the future cash inflows of our project have been discounted and brought to time zero so that they can be compared to the initial investment being done in the project.
PVIF* 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 PV of Cash Inflows# 90,764 86,003 55,085 37,462 29,288 20,028 Net Present Value Net Present Value is the difference between the present values of the cash inflows and outflows. It is calculated to decide on an investment decision as it shows the profitability of the respective project. If the NPV is positive, we accept the project as it denotes the addition of value to the firm.
If the NPV comes out to be negative, we reject the proposal and the project is not carried forward. NPV is defined as: 1 Therefore, in this scenario NPV = -Initial Cost + PV of Cash Flows NPV = (320,000) + 90,764 + 86,003 + 55,085 + 37,462 + 29,288 + 20,028 NPV = ($1,370) Conclusion and Recommendations Since the NPV of this project is negative, the project should not be carried on. Therefore, Watson Leisure Time Sporting Goods should not purchase the new equipment as the project does not add value to the company and will not further enhance the operations.
I recommend that the company should move to another type of machinery or another project that is feasible as well as adds value to the company. References Brealey, R. A. (2007). Principles of Corporate Finance. McGraw-Hill. Investopedia. Net Present Value-NPV. Investopedia. Accessed from http: //www. investopedia. com/terms/n/npv. asp on 20-02-2010