LECTURE ACTIVITY – ENPV

Ericus plc uses Net Cash flows from operations to evaluate investment projects. The
company provides street-cleaning services for local councils in the UK. The company intends
to invest £800,000 to purchase a fleet of street-cleaning vehicles. The vehicles have a life of
five years and are likely generate cash flows. Below is information to help you to estimate the
Net Cash flows from operation and their probability of occurrence are set out below.

Net Profit Probabil Impairme Loss/ Change Net

Before ity of nt Profit on in Cash
Interest and occurre Loss Sale Working Flows
  Tax nce Capital
Year 1 180,000 0.3 20,000 200,000
Year 1 160,000 0.5 (15,000) 145,000
Year 1 130,000 0.2 10,000 120,000

Year 2 124,000 0.4 124000

Year 2 132,000 0.4 25,000 8,000 165,000
Year 2 135,000 0.2 135,000

Year 3 124,000 0.4 10,000 114,000

Year 3 130,000 0.3 15,000 145,000
Year 3 133,000 0.3 133,000

Year 4 120,000 0.3 120,000

Year 4 127,000 0.6 (17,000) 144,000
Year 4 130,000 0.1 10000 5,000 145,000
Year 5 180,000 0.3 180,000
Year 5 124,000 0.4 20,000 (4,000) 140,000
Year 5 133,000 0.3 (8,000) 7,000 148,000

Cash flow estimates for each year are independent of other years. The business has a cost of
capital of 10 per cent.

REQUIRED:

(a) Calculate the expected net present value (ENPV) of the street-cleaning machines and
advise the management of the company whether they should buy the machines or not

(b) Calculate the net present value (NPV) of the worst possible outcome and the
probability of its occurrence

(c) Why do businesses use cash flows not profit in investment appraisal?
 Net Profit Probabil Net EXPECTED ANNUAL DCF EPV
CASHFLOWS EXPECTE
Before ity of Cash D
Interest and occurre Flows CASHFLO
  WS
Tax nce
Year 1 180,000 0.3 200,000 60,000
Year 1 160,000 0.5 145,000 72,500
Year 1 130,000 0.2 120,000 24,000 156,500 0.9091 142,274

Year 2 124,000 0.4 124000 49,600

Year 2 132,000 0.4 165,000 66,000
 Year 2 135,000 0.2 135,000 27,000 142,600 0.8264 117,845

Year 3 124,000 0.4 114,000 45,600

Year 3 130,000 0.3 145,000 43,500
Year 3 133,000 0.3 133,000 39,900 129,000 0.7513 96,918

Year 4 120,000 0.3 120,000 36,000

Year 4 127,000 0.6 144,000 86,400
Year 4 130,000 0.1 145,000 14,500 136,900 0.6830 93,503

Year 5 180,000 0.3 180,000 54,000

Year 5 124,000 0.4 140,000 56,000
Year 5 133,000 0.3 148,000 44,400 154,400 0.6209 95,867
546,407

EPVs == 546, 407

Initial Outlay === 800,000

ENPV = 546, 407 – 800,000

ENPV = 253,593 NEGATIVE

DECISION: Investment is not viable because ENPV is

negative. Therefore, management should not go ahead.
However, management should consider alternative investment
opportunities after evaluating the validity of the cashflow
estimates, discount rate and the duration of the protect. They
should consider the IRR and other sources of funds.
Qualitative Factors –
1. Missing deadlines and its effect on reputation
and credibility
2. CSR and environmental factors
3. Decrease in staff morale
It makes us vulnerable to our competitors and
weakens our competitive position