How to measure the value of a capital budgeting project based on financial measu

Question

How to measure the value of a capital budgeting project based on financial measures or formulas. However, certain projects can have significant impacts on a company, both positive and negative, that can't be quantitfied using a formula.

Required: Your firm is considering closing a plant that employs 5,000 people in a small town of 20,000 people in central Florida. The company will relocate the plant to a metropolitan city of with more than 1 million people.

What are some of the positive and negative impacts of this capital budgeting decision? What can the firm do mitigate some of the negative impacts?

For example, one negative impact would be the loss of income to 25% of the people in the small Florida town.Type your question here

Explanation / Answer

Net present value is the present value of net cash inflows generated by a project including salvage value, if any, less the initial investment on the project. It is one of the most reliable measures used in capital budgeting because it accounts fortime value of moneyby using discounted cash inflows.

Before calculating NPV, a target rate of return is set which is used to discount the net cash inflows from a project. Net cash inflow equals total cash inflow during a period less the expenses directly incurred on generating the cash inflow.

The first step involved in the calculation of NPV is the determination of the present value of net cash inflows from a project or asset. The net cash flows may be even (i.e. equal cash inflows in different periods) or uneven (i.e. different cash flows in different periods). When they are even, present value can be easily calculated by using thepresent value formula of annuity. However, if they are uneven, we need to calculate the present value of each individual net cash inflow separately.

In the second step we subtract the initial investment on the project from the total present value of inflows to arrive at net present value.

Thus we have the following two formulas for the calculation of NPV:

When cash inflows are even:

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