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179 浏览Part 2(a) Evaluating and Assessing Investment Opportunities
1. Introduction: Newton Electronics Ltd, known for its high-tech research and development prowess, holds a strong market position due to its innovation and technological leadership. The company is now embarking on a significant transition, moving from a focus on R&D to manufacturing, with the development of a new type of miniature hearing aid. This pivot is crucial for Newton Electronics Ltd's future market positioning and financial performance. Therefore, a comprehensive financial evaluation of this investment opportunity is essential to ensure the project's success and to understand the company's long-term strategic direction.
Research indicates the importance of a systematic and transparent approach in evaluating new technology investments outside a company's core business. This approach mitigates the risk of misjudgment due to decision-makers' lack of experience and knowledge in new domains. It is advised to base investment decisions on the potential, company-specific utility of technologies rather than traditional financial indicators like return on investment (ROI) at early stages of development, due to prevalent uncertainties (Schuh, Scholz, & Ando, 2020).
Additionally, the role of corporate governance and financial performance is significant in the development of corporate innovation investments. Acting transparently and honestly with all stakeholders enhances the economic sustainability of the country through efficient management of financial resources and high value-added innovation. This perspective is critical for Newton Electronics Ltd as it pivots to manufacturing and production (Benetytė, Gonenc, & Krušinskas, 2021).
2. Calculation of Annual Cash Flows (i):
In order to calculate the annual cash flows for the Newton Electronics Ltd project, we must consider the following aspects:
Initial Investment:
Equipment costs amount to $9 million.
Working capital needs are projected at $3 million.
Forecasting Sales and Costs:
Annual sales revenue will be calculated using the provided data (number of units x selling price).
Variable costs are estimated at $14 per unit.
Fixed costs, including depreciation, are expected to be $2.4 million per year.
Marketing expenses are anticipated to reach $2 million per year.
Depreciation Calculation:
The residual value is projected to be $1 million at the end of 5 years.
Assuming straight-line depreciation, the annual depreciation expense = (cost of equipment residual value) / useful life.
With this information, a detailed cash flow statement can be prepared, showcasing the cash flows from year 0 to year 5. When computing cash flows, all related incomes and expenses must be taken into account, including the purchase of equipment, operational costs, sales revenue, and depreciation charges (Brealey, Myers & Allen, 2020).
Cash Flow Statement in USD
Note: Sales revenue is calculated based on forecasted sales volume and selling price. Variable costs are computed by multiplying the unit cost by the sales volume. Depreciation expense is based on the cost of equipment minus the residual value, evenly distributed over five years. The annual cash flow is the result of income minus all costs and expenses for each year (Brealey, Myers & Allen, 2020).
The 0th year in the cash flow statement represents the initiation phase of the project, typically reflecting the initial capital expenditure required before the start of the project(Garratt & van Oordt, 2021). This 0th year is considered a preparatory period, during which the project has not yet commenced operations, thus generating no sales revenue but incurring start-up costs, such as the purchase of equipment and the injection of working capital. These outlays are essential early investments made to acquire assets and establish operational capabilities, allowing the project to begin generating income from the 1st year onwards(Brealey, Myers & Allen, 2020).
When calculating the Net Present Value (NPV), the cash flow of the 0th year is not discounted, as it represents the current investment at the time of project evaluation. Cash flows starting from the 1st year onward need to be discounted because they occur in the future, and discounting reflects the time value of money, meaning the value of money now is higher than the same amount in the future (Brealey, Myers & Allen, 2020).
In the cash flow overview you mentioned, the initial year's cash flow is marked as -$12,000,000, indicating the necessity for the firm to allocate $12 million initially for equipment acquisition and providing required working capital prior to the project's initiation. This initial outlay is a pivotal element in determining the financial practicability of the project, as all ensuing profits and expenditures stem from this primary investment (Brealey, Myers & Allen, 2020).
Moreover, the initial investment is usually a substantial one-time expense, while future cash flows, such as sales revenue and related operational costs, are distributed over time. Therefore, starting the cash flow statement from the 0th year helps distinguish between the start-up costs of the project and its financial activities during the operational period. This presentation provides a clear starting point for the overall financial analysis of the project(Ross, Westerfield & Jaffe, 2020).
3. Calculation of Net Present Value (NPV) (ii):
NPV calculation involves discounting future cash flows to their present worth using the following formula:
where is the cash flow in year t, r is the discount rate (in this case, 10%), and n is the duration of the project.
Based on the annual cash flows calculated earlier, we can insert these values into the formula to calculate the NPV. For instance, for the first year, the cash flow is $7,800,000, and the discounted cash flow is . Similarly, we calculate the discounted cash flows for other years, sum them up, and subtract the initial investment to obtain the NPV of the project.
NPV approach evaluates investment profitability, considering time value of money.The NPV method is especially useful in determining whether the anticipated returns from a project exceed its initial outlay, thereby justifying the investment decision (Brealey, Myers & Allen, 2020).
The calculation process for the Net Present Value (NPV) in the first year is as follows:
Given data:
Cash flow for the first year: $7,800,000
Discount rate: 10% (i.e., 0.10)
Calculation formula:
Substituting the values into the formula:
Calculation result:
Thus, the Net Present Value for the first year is approximately $7,090,909.09.
For subsequent years, calculate NPV using specific cash flows.Positive NPV indicates project worthiness.This method assesses profitability, considering time value of money.Essential tool for informed investment decisions, aligning returns with company goals.
Following the same method:
The Net Present Value (NPV) for the second year:
Cash flow for the second year: $5,200,000
Discount rate: 10% (i.e., 0.10)
Therefore, the Net Present Value for the second year is approximately $4,297,520.66. This value reflects the present value of the cash flow generated in the second year, taking into account the time value of money. It indicates that when discounted at the given rate, the future cash flow of the second year holds this value in current terms (Brealey, Myers & Allen, 2020).
The Net Present Value (NPV) for the third year:
Cash flow for the third year: $7,800,000
Discount rate: 10% (i.e., 0.10)
Therefore, the Net Present Value for the third year is approximately $5,860,256.35.
The Net Present Value (NPV) for the fourth and fifth years:
Given data:
Cash flow for the fourth year: $3,600,000
Cash flow for the fifth year: -$3,000,000
Discount rate: 10% (i.e., 0.10)
Therefore, the Net Present Value for the fourth year is approximately $2,460,358.29, while for the fifth year, it is approximately -$1,863,112.52. These values reflect the current value of the cash flows generated in the fourth and fifth years after considering the time value of money (Brealey, Myers & Allen, 2020).
When we take into account the NPV results from all five years and compare them against the initial investment, we get the following NPV values for each year:
First year: approximately $7,090,909.09
Second year: approximately $4,297,520.66
Third year: approximately $5,860,256.35
Fourth year: approximately $2,460,358.29
Fifth year: approximately -$1,863,112.52