Cash Flow Estimation
SECTION 1: Cash Flow Decision Criterion
In deciding whether or not to implement a new product line, Indian River needs to first evaluate the projects expected cash flow. The expected cash flow is important for a number of reasons. It can help to evaluate the expected performance of the project, to determine if there may be problems with liquidity, and to calculate primary decision criterion to use in the evaluation of the product lines implementation. The decision criterions include the projects Net Present Value, Internal Rate of Return, Modified Internal Rate of Return, Payback Period, and Profitability Index.
Net Present Value
A projects net present value (NPV) is the total present value of a time series of cash flows. It is used for capital budgeting as an indicator of how much value an investment or project adds to the value of the firm. NPV is calculated by discounting each cash inflow/outflow back to its present value and then summing these values together. Appendix A, on page 11, shows the new product lines operating cash flows and the calculation of its NPV. At 0% inflation, the projects NPV is calculated to be $23,720. At 5% inflation, the NPV is $74,182. At 5% price inflation and 2% cost inflation, the projects NPV is $166,719.
Internal Rate of Return
The internal rate of return (IRR) is another measurement in capital budgeting used to decide whether a company should make an investment. It is different from the NPV in that it is an indicator of a projects efficiency rather than its value. Using the model in Appendix A and the IRR function in Microsoft EXCEL, the new product lines IRR is calculated, at 0% inflation, to be 11.90%. At 5% inflation, the IRR is 15.74%. At 5% price inflation and 2% cost inflation, the projects IRR is 22.21%.
Modified Internal Rate of Return
The modified internal rate of return (MIRR) is similar to a IRR except that it measures the rate of return...