Analyze the following scenario: Duncombe Village Golf Course is considering the purchase of new equipment that will cost $1,200,000 if purchased today and will generate the following cash disbursements and receipts. Should Duncombe pursue the investment if the cost of capital is 8 percent? Why? Clearly label your calculations in your analysis. You must respond to at least two of your classmates’ postings to receive full credit.
Year
Cash Receipts
Cash Disbursements
Net Cash Flow
1
1,000,000
500,000
500,000
2
925,000
475,000
450,000
3
800,000
450,000
350,000
4
750,000
430,000
320,000
To analyze whether Duncombe Village Golf Course should pursue the investment, we need to calculate the net present value (NPV) of the cash flows.
NPV is calculated by discounting each cash flow to its present value and then summing them up. The formula to calculate NPV is:
NPV = Σ(Cash Flow / (1 + r)^t)
Where:
Cash Flow = Net cash flow for each year
r = Cost of capital (in this case, 8% or 0.08)
t = Year
Using the given cash flows and cost of capital, we can calculate the NPV as follows:
Year 1:
NPV1 = 500,000 / (1 + 0.08)^1 = $462,963.00
Year 2:
NPV2 = 450,000 / (1 + 0.08)^2 = $380,208.33
Year 3:
NPV3 = 350,000 / (1 + 0.08)^3 = $275,366.35
Year 4:
NPV4 = 320,000 / (1 + 0.08)^4 = $229,637.57
To calculate the overall NPV, we sum up the discounted cash flows:
NPV = NPV1 + NPV2 + NPV3 + NPV4
= $462,963.00 + $380,208.33 + $275,366.35 + $229,637.57
= $1,348,175.25
Since the NPV is positive ($1,348,175.25), Duncombe Village Golf Course should pursue the investment. A positive NPV indicates that the present value of the cash inflows is greater than the present value of the cash outflows, which means the investment is expected to generate a positive return.
It is recommended for Duncombe Village Golf Course to pursue the investment as it is expected to create value for the business.
To determine whether Duncombe Village Golf Course should pursue the investment, we need to calculate the Net Present Value (NPV) of the cash flows. The NPV measures the profitability of an investment by discounting future cash flows back to the present value, taking into consideration the cost of capital.
1. Calculate the present value factor:
To discount the future cash flows, we need to calculate the present value factor for each year based on the cost of capital. The formula for the present value factor is:
PV Factor = 1 / (1 + r)^n
Where:
r = cost of capital (8%)
n = year
For example, in year 1:
PV Factor = 1 / (1 + 0.08)^1 = 0.9259
Similarly, calculate the PV Factor for each year.
2. Calculate the discounted cash inflows and outflows:
To determine the net cash flow for each year, multiply the cash inflows and outflows by the PV Factor.
For example, in year 1:
Discounted Cash Inflows = 1,000,000 * 0.9259 = 925,900
Discounted Cash Outflows = 500,000 * 0.9259 = 462,950
Net Cash Flow = Discounted Cash Inflows - Discounted Cash Outflows = 925,900 - 462,950 = 462,950
Similarly, calculate the Net Cash Flow for each year.
3. Calculate the NPV:
The NPV is the sum of the discounted net cash flows for each year.
NPV = Σ(Net Cash Flow) - Initial Investment
For this scenario:
Initial Investment = $1,200,000
Calculate the NPV by adding up the Net Cash Flow values and subtracting the initial investment.
4. Evaluate the investment:
If the NPV is positive, it means the investment is profitable and should be pursued. If the NPV is negative, it means the investment is not profitable and should be avoided.
Now, take the net cash flows calculated for each year and subtract the initial investment to calculate the NPV.
For example, in year 1:
NPV = 462,950 - 1,200,000 = -737,050
Similarly, calculate the NPV for each year and overall.
Based on the NPV calculated, determine whether the investment should be pursued or not. If the NPV is positive, the investment is profitable and should be pursued. If the NPV is negative, the investment is not profitable and should be avoided.