Running head: NET PRESENT VALUE 1

Written Assignment Week 2

Net Present Value for We Promote Company Business Expansion Project

BUS 5111 Financial Management

Term 4, 2018-2019

University of the People

NET PRESENT VALUE 2

Net Present Value for We Promote Company Business Expansion Project

Net Present Value

Used in capital budgeting and investment planning to analyze the profitability of a

projected investment or project, the Net Present Value (NPV) is a calculation that compares the

amount invested today to the present value of the future cash receipts from the investment

(Kenton, 2019).

NPV is calculated by first getting the Present Value = Future Value / [(1+discount

rate)^year] (Seth, 2019). After which, the NPV shall be obtained by adding the present values for

the given period (Seth, 2019).

In the case of We Promote, both partners have given their projected cash inflow for seven

years and an assumed discount rate of 6%.

Table 1: NPV Calculations Based on the Values Given by Two Partners

Partner 1 Partner 2
Year
Cash Flow Present Value Cash Flow Present Value

0 -$75,000 -$75,000 -$75000 -$75,000

1 $15,000 14,150.94 $14,000 13,207.55

2 $15,000 13,349.95 $14,000 12,459.95

3 $15,000 12,594.29 $15,000 12,594.29

4 $15,000 11,881.40 $15,000 11,881.40

5 $15,000 11,208.87 $17,000 12,703.39

6 $15,000 10,574.41 $17,000 11,984.33

7 $15,000 9,975.86 $17,000 11,305.97

Net Present Value $8,735.72 $11,136.88

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It is worthy to note that due to inflation, the projected value of money or cash inflows

given in the present will not be the same in the future, hence, the discount rate element of the

NPV formula is used to account this (Kenton, 2019). Furthermore, the negative value in year

zero represents the initial investment cash outflow from purchasing the equipment.

A positive net present value indicates that the projected earnings from an investment

exceeds the anticipated costs and can be assumed to be profitable while a negative NPV will

result in a net loss (Kenton, 2019). Therefore, based on the given data alone, the company will

have a positive net present value of $8,735.72 and $11,136.88 respectively, and these values

merit a decision to pursue this business opportunity.

However, the values given in the case study are limited to the acquisition value, projected

cash inflows, and discount rate. Other costs deemed relevant and will have an impact on the cash

flows, such as the maintenance of the equipment, are not included. Taking this into

consideration, another analysis should be performed to arrive at a more accurate net present

value. Should the NPV after the re-calculation becomes negative, the project should not be

pursued.

Assuming that the business partner insists on pursuing the project despite the negative net

present value, the return of investment of 11.64% for seven years will be stressed out.

Furthermore, the costs that might be incurred for the maintenance of the equipment could

decrease the already low net present value. Lastly, the $5,000 estimated value of the equipment’s

parts at the end of seven years is not guaranteed and will depend on the performance and

maintenance of the equipment.

In conclusion, net present value is a useful method to evaluate the profitability of an

investment but it also has certain limitations such as the use of cash flow and cost estimates
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(Woodruff & Thompson, 2019). In the case of We Promote, the business partners should

consider re-evaluating their expansion plan to include a more solid strategy that will ensure to

generate additional income for the company in order to increase the net present value and cover

all the costs that might be incurred.

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References

Kenton, W. (2019, February 10). Net present value. Retrieved from

https://www.investopedia.com/terms/n/npv.asp

Seth, S. (2019, February 2). What is the formula for calculating net present value (NPV) in

Excel? Retrieved from https://www.investopedia.com/ask/answers/021115/what-formula-

calculating-net-present-value-npv-excel.asp

Woodruff, J. & Thompson, J. (2019, January 25). Advantages & disadvantages of net present

value in project selection. Retrieved from https://smallbusiness.chron.com/advantages-

disadvantages-net-present-value-project-selection-54753.html