Report–Surf the Waves Limited
Report–Surf the Waves LimitedInvestment Evaluation Criterion Initial Capital BudgetingLower by 15%Higher by 15%Present Value (PV)$1,154,377.55 $1,112,282.37 $1,196,472.74 Net Present Value(NPV)$32,502.55 ($9,592.63)$74,597.74 Internal Rate of Return(IRR)15.08%13.61%16.48%Present Value Index(PVI)1.030.991.07Payback Period3.593.673.53Discounted Payback Period4.87>5.04.72Statement of AssumptionsTo show the analysis of cash flows based on different scenarios, we get three groups of investment evaluation data by making assumption that Surf the Waves Limited would replace the existing machine with a new one. The data include one initial capital budgeting cash flows and two uncertain cash flows according to sensitivity analysis.
Required Rate of ReturnRequired rate of return is the minimum percentage earned by an investment that corporates would expect when they consider putting money into a project (Required Rate of Return – RRR 2015). We calculate the rate by building a capital asset pricing model (CAPM) based on the market information of Surf the Waves Limited, and then apply to evaluate the project of replacing the existing machine. CAPM formula has three components in determining expected return, the risk-free rate, the market risk premium and the beta coefficient, of which beta 1.08 implies the asset of Surf the Waves Limited has more systematic risk than the overall market (Allport 2015). In this way, a more accurate required rate of return was derived by the company individually. Evaluation CriterionNet Present Value (NPV)With the financial goal of maximizing shareholders’ wealth, a company should consider the investment that would create value to the shareholders. Net Present Value (NPV) is the difference between an investment’s market value (in today’s dollars) and its cost (also in today’s value) (Allport 2015). Hence, NPV provides a direct measure in capital budgeting to determinate the profit an investment could bring to the company.As we can see from the above table, the investment of replacing existing machine would have a NPV of $32,502.55 in today’s value. Since this number is positive, it means that the replacement is expected to add value of $32,502.55 to Surf the Waves Limited. The NPV is even higher if we assume that the operating costs would be higher by 15% in each of the fourth and fifth year, by achieving $74,597.74. However, the NPV would be a negative number of -$9,592.63 if operating costs being lower by 15%, under this assumption the investment is not worthwhile undertaking for the company.