Caterpillar is considering building a production facility in Argentina. The plan

Question

Caterpillar is considering building a production facility in Argentina. The plan is to fund have of the initial capital outlay by borrowing funds in Argentina and using funds from the parent company’s equity. Caterpillar will assess the project from the parent’s perspective to determine the project’s cash flows and if the project has a positive NPV and should be pursued. Why would the cash flows in the Argentina project be different than the same project in Illinois? Why would the initial outlay be different (Or would it be?)

Explanation / Answer

Net Present Value Method:-

The net present value (NPV) method calculates the expected financial gain or loss from a project by discounting all expected future cash inflows and outflows back to the present point in time using the required rate of return. Only projects with a positive NPV are acceptable because the return from these projects exceeds the cost of capital (the return available by investing the capital elsewhere).

Net present value is calculated by dividing the expected income of a project in each future year by a term equal to one plus a discount rate raised to a power equal to the year. The totals for each year then are added together, and the initial cost of the project is subtracted from that sum to arrive at the net present value. The discount rate represents the time value of money: the amount that could be made by committing the money to other opportunities.

Positive Net Present Value –The purpose of net present value is to help analysts and managers decide whether or not new projects are financially viable. Essentially, net present value measures the total amount of gain or loss a project will produce compared to the amount that could be earned simply by saving the money in a bank or investing it in some other opportunity that generates a return equal to the discount rate. If a long-term project has a positive net present value, then it is expected to produce more income than what could be gained by earning the discount rate, which means the company should go ahead with the project.

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.