Financial Management for Cash Outflows - MyAssignmenthelp.com

Question: Discuss about theFinancial Management for Cash Outflows. Answer: Ed Analysis is not correct. Ed has not correctly expected NPV of the product. The probability of happening and non-happening of any event can never be equal that is 98% each it has to be equal to 100%. Ed reasoning of multiplying of two probabilities i.e. (98x98)%= 96% and then reducing the cash inflows by 4% is totally incorrect. The product NPV is the correct way of appraising the project but not in the way Ed has calculated. CFO risk assessment is correct and is to be correctly calculated. $ 20 million is a very substantial amount for a company like Airway to invest. In case the product is not accepted, the company may face bankruptcy or closure of business. Financial prudence is very important for project acceptance. It is clearly seen that if ED product is not accepted, Airway Company will lose everything they have invested in the product development. The correct method of calculating NPV is Present value of Cash inflows Present value of cash outflows (Correia et. al, 2005). NPV: PVCI-PVCO Where PVCI is Present value of Cash inflows PVCO is Present value of Cash outflows Cash outflows are done at zero period that is an initial period while cash inflows are spread over no. of years (example: 5 years) depending upon product expected sale life. A suitable discounting rate is used to discount the cash inflows and outflows. In case NPV is positive, the product or the project should be accepted otherwise in case NPV is negative, the product or the project should be rejected (Albrecht et. al, 2011). So the product introduced by ED should be judged on NPV criteria and not on ED calculations. We would like to explain this with an example: Initial Investment of a project: 130000 $ Expected life of product: 4 years Discount Rate: 12% PV factors at 12% YEAR OUTFLOW INFLOW in $ PV FACTOR @ 12% * PVCI in $ 0 -130000 $ 1 1 25000 0.8928 22320 2 35000 0.7971 27898 3 55000 0.7117 35585 4 75000 0.6355 47662 TOTAL -130000 $ 133465 $ *1 / 1.12= 0.8928, 0.7971, 0.7117, 0.6355. We can see in the example that Present value of cash outflows PVCO is 130000 in negative which means this is a cash outflow is made at zero periods while the present value of cash inflows PVCI is + 133465. This shows that in case this project is accepted, the Net present value of this has covered its cost outflow and it is in positive. Here we can say that NPV is 3465 (133465-130000), the project may be accepted. Similarly, Ed is hereby advised that he should not use his imaginary calculations for project appraisal and acceptance of his product. CFO of the company is correct that the NPV calculation is wrong (Healy Palepu, 2012). CFO contention is right and it is seen very clearly. The CFO has correctly signified the wrong calculation and hence, Ed should drop the way fo computation. So we may conclude that Ed method of calculating NPV is wrong and his statistical calculations are vague. He should revise his calculation of NPV and IRR and use correct NPV calculations. There are some deficiencies in the computation and hence, a correct decision will not be possible by considering this. The imaginary calculations if used can lead to severe problems and many complications might arise on the project appraisal (Henderson et. al, 2015). In all probability, the computation should be done as per the accepted method and there be no place for imaginary calculations. References Correia, C, Mayall, P, O'Grady, B Pang, J. 2005. Corporate Financial Management, 2nd ed. Perth: Skystone Investments Pty Ltd. Henderson, S, Peirson, G, Herbohn, K, Howieson, B. (2015). Issues in financial accounting. Pearson Higher Education AU. Healy, P. M, Palepu, K. G. (2012). Business Analysis Valuation: Using Financial Statements. Cengage Learning. Albrecht, W, Stice, E Stice, J. (2011). Financial accounting. Mason, OH: Thomson/South-Western.