1/. The company ABC is considering two mutually exclusive investment programs which have a lifetime of two years. The cash flows of the two programs (in thousands of euros), as well as the corresponding probabilities of their realization are presented in the following tables: Year 0 Year 1 Cost Probability Cash Flow -400 Year 0 40% -700 60% Cost Probability Cash Flow 35% Year 1 65% INVESTMENT A 440 380 INVESTMENT B 480 Year 2 Potential Cash Flow 60% 40% 70% 30% 340 Chance Year 2 40% 60% 55% 45% 460 420 410 360 Cash Flow 490 480 380 330 AV. Consider, based on the criterion of Expected Net Present Value, which of the two investments would you choose, given that the weighted average cost of capital in the case of Investment A is estimated at 10%, Investment B at 8%, while the risk-free rate is 3%. B/. Let's say at the end of the first year a prospective buyer comes along and makes an offer to buy the investment you chose to implement in question a/. According to his offer, he intends to buy it instead of the amount of 400,000 euros. Given his offer, justify whether or not it is profitable to sell the investment at the end of the first year.
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
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