Present Value

Topics: Net present value, Internal rate of return, Time value of money Pages: 8 (1404 words) Published: May 19, 2014

Net present Value, Mergers and acquisitions
Main objective of undertaking this to report was learn about NPV present value (NPV) method to make capital budgeting decision(Google NEW Project) and success factors involved in mergers and acquisitions(Google-Groupon Case). Answers to the Assignments

Part I: Google should go ahead with the new project.
Part-II: Google’s acquisition of Groupon would have been win -win situation for both corporations Now I will discuss both parts in detail below.
Part I: Capital Budgeting
Capital budgeting is the process of making long-term planning decision relating to planning for capital assets as to whether or not money should be invested in the long term projects ( Decisions like obtaining new facilities or purchase or new machinery to expand their business. It involves a financial analysis of the various alternative proposals regarding a capital expenditure and to select the best out of the several alternatives. There are several methods of evaluating investment projects like NPV, IRR, Payback period and Profitability Index ( I will be discussing NPV and IRR for this assignment.

Net Present Value (NPV)
NPV is a method which uses discounted cash flow techniques. Net Present Value is equal to the difference between the Present Value (PV) of the future cash inflows over the immediate cash outflow (Initial Investment - I). Simply put NPV=PV-I ( PV is calculated using the cost of capital (also called minimum required rate of return or hurdle rate) as the discount rate. Decision Rule: If NPV of project is positive, it is accepted, otherwise it is rejected ( “Since NPV represents the contribution to the wealth of the shareholders maximizing NPV is congruent with the objective of investment decision making viz. maximization of shareholder wealth” ( Advantages of NPV Method:

a) It obviously recognizes the time value of money and considers the cash flow stream in its entirety. b) It is particularly useful for selection of mutually exclusive projects. c) It represents the contribution to the wealth of the shareholders and thus it helps in achieving maximization of shareholders wealth

Disadvantages of NPV Method:
a) It requires detailed long term forecasts of incremental cash flows which are difficult o predict accurately. b) Computation of minimum required rate of return or hurdle rate can be cumbersome and it can change after some years. c) NPV method might not give satisfactory result if projects being compared are of different time durations. d) This method involves computation of only NPV, so this method cannot be used for capital rationing as it disregards initial investment involved. Internal rate of Return (IRR): It is that rate of interest at which the NPV of a project is equal to zero or the rate of interest which equates initial investment (I) with the present value of the cash outflows. In other words, at IRR, I=PV or NPV=0. Decision Rule: If IRR exceeds the cost of capital (k), project is accepted otherwise it is rejected ( Google New Project Case

Cost of Capital
Discount Rate ( r)

Cash Flow(CF)
Present Value of Cash Flows (CF*(1/(1+r))^t))

Present Value (PV) of Cash Inflows = CF1 / (1+r)1 + CF2 / (1+r)2 + CF3 / (1+r)3 + CF4 / (1+r)4 + CF5 / (1+r)5 Present Value of Cash Inflows =$307,018+$484,765+$472,480+$325,644+$441,463=$2031370 Net Present Value (NPV) of Project = Present Value of Cash Inflows - Initial cash outflow NPV=$2031370-$175000=$281370

Net Present Value of Cash Flows
These values are found using

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