Computing Cash Flow From Investment And Net Present Value Accounting Essay

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The expected period of time during which an asset is useful to the average owner. The economic life of an asset could be different than the actual physical life of the asset. Estimating the economic life of an asset is important for businesses so that they can determine when it is worthwhile to invest in new equipment. In addition, businesses must plan so that they have sufficient funds to purchase replacements for expensive equipment once it has exceeded its useful life.

SCAP VALUE: an incidental output of a joint process; it is salable but the sales value from scrap is not enough for management to justify undertaking the joint process; it is viewed as having a lower sales value than a by-product; leftover material that has a minimal but distinguishable disposal value.

CASH FLOWS FROM INVESTMENT: Cash flow analysis is a critical process for both companies and investors. It's also a complex process that can leave the average investor with the feeling that delegating security analysis to a competent financial advisor just might be a good idea. Cash Flow investments are investments that provide regular monthly, quarterly, or annual payments.  In almost all cash flow investments, the general principle is the same;  an investor puts up a lump sum in order to receive re-occurring payments and therefore, receives a return on investment. When you start to incorporate cash flow into your portfolio, a new world of financial possibilities appears at your fingertips.  These investments are structured to yield reliable and dependable returns, which give you the power to plan your financial future. Examples of cash flow investments:

Residential Real Estate: The most well known form of cash flow investing is purchasing residential real estate to use as rental property.   In this investment, you put up a lump sum of cash to purchase the property in order to receive the monthly income that the rent of the property produces.

Returns: 8-17%

Time Horizon: Varies.

DEPRECIATION : In a broader economic sense, the depreciated cost for industry is the aggregate amount of capital that is "used up" in a given period, such as a fiscal year. This value can be examined for trends in capital spending and accounting aggressiveness. 

The value of an asset net of all accumulated depreciation that has been recorded against it.

Depreciated Cost = Purchase Price (or cost basis) - {Cumulative Depreciation}

Depreciated cost is also known as the "net book value" or "adjusted cost basis".

STRAIGHT LINE METHOD OF DEPRECIATION: Straight-line method of depreciation is the most popular and simple method of depreciation. In this method, the purchase price or the acquisition value of the asset is divided by the useful life of the asset after deducting the scrap value from the value of an asset. Scrap value of the assets is the value of the asset at which it can be sold after its useful life is over. In order to understand the straight-line method of depreciation better.

NET PRESENT VALUE: The Net Present Value (NPV) of a Capital Budgeting project indicates the expected impact of the project on the value of the firm. Projects with a positive NPV are expected to increase the value of the firm. Thus, the NPV decision rule specifies that all independent projects with a positive NPV should be accepted. When choosing among mutually exclusive projects, the project with the largest (positive) NPV should be selected. The NPV is calculated as the present value of the project's cash inflows minus the present value of the project's cash outflows. This relationship is expressed by the following formula:

http://www.zenwealth.com/BusinessFinanceOnline/CB/images/NPV.gif

where,

CFt = the cash flow at time t and

r = the cost of capital.

CALUCATION OF CASH FLOWS

Particulars

Amount

Profit before tax and depreciation(PBT)

--- Depreciation(w.note)

2,00,000

---1,53,343

Profit before tax

--- Tax@50%

46,657

--- 23,329

Profit after tax (PAT)

23,328

Cash inflow (each year) = Profit after tax (PAT) + depreciation

= 23,328 + 1,53,343

= Rs.1,76,671

Terminal inflow in the 7th year = Rs.30,000 (scrap value)

WORKING NOTES-:

Calculation of depreciation

= Cost of plant + installation cost - scrap value

Economic life

= 11,00,000 + 3,400 - 30,000

7yrs

= Rs.1,53,343

CALCULATION OF NET PRESENT VALUE

Year

cash inflow

PVF(10%,n)

Total PVF (Rs.)

1

1,76,671

0.909

1,60,594

2

1,76,671

0.826

1,45,931

3

1,76,671

0.751

1,32,680

4

1,76,671

0.683

1,20,667

5

1,76,671

0.621

1,09,713

6

1,76,671

0.564

99,643

7

1,76,671+30,000 =2,06,671

0.513

1,06,022

Total of inflows 8,75,250

Less: cash outflow (at time 0)-11,03,340

(Plant cost +installation charges)

NPV (2,27,975)

NPV = PRESENT VALUE OF CASH INFLOW -- PRESENT VALUE OF CASH OUTFLOW

CONCLUSION

Since the NPV of the proposal is negative, the proposal needs to be rejected.

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