How Each Option Could Change a Net Present Value Project’s
Net Present Value refers to submission of present values of each of the cash flows within the same entity. It usually occurs over time and affects both the incoming and outgoing cash flows. There are several changes incurred in the cash flow system that affects NPV. These changes are dependent on the following factors: abandonment, timing, growth and flexibility.
Abandonment of the project changes the cash flow and affects the number of sales made by the company.
On the other hand, timing affects discount made on the cash flows. It renders discount flexible depending on the nature of the business environment at a particular time. The discounts on an investment made today may not be affected by time factor while the same investment made a year later will be affected by.
Growth is a determinant of future investments made by a company. It is likely to have an impact on the projects NPV in regard to cash flows which are in turn affected by investments.
Flexibility enables a company to determine the appropriate measure to be undertaken. This is reflected in the project’s NPV times that will call for a change in the course taken in order to enhance on the cash flows of the company (Bloom 213).
The risks involved in each of the options are evident in a project’s NPV. There are situations that will call for abandonment of the project in effort to sustain the cash flow and maintain the NPV. On the other hand, timing as a factor is crucial in handling a situation that may affect the NPV in the future. This calls for an earlier solution for situations likely to arise in the future. A project’s growth involves acting on the available investment options since it has a great impact on the future strength of the company’s cash flow, a factor whose negligence may lead to instability of the project. Flexibility as an option helps check the risks that may be incurred as a result of failing to take the necessary actions (Foran 324).
For example, a company may opt to pursue a different direction to enhance its cash flows. In a case where the project is unsure of achieving a positive NPV, the company may decide to abandon the project. However, this will be in accordance with the indication that the timing will enhance the company’s cash flow and thus aid in sustenance of the NPV. This is a flexibility change that is only taken for the specific moment and will enable a continued growth of the NPV of the company (Falcon 112).
A firm’s size of corporate capital may not affect WACC by boosting capital through means such as equity in financing among others. However, this is highly affected if the company will use retained earnings to boost its capital. This is because there is no cost of the institution towards raising the funds. In this instance, WACC would not have to depend on the budget’s capital size but rather the other available sources especially their size (Cromwell 1).
The 2008 credit crisis had a big impact on the capital budget of various investments. To begin with, many banks had to review their lending terms. In this case the investments that relied on loans to fund their budget capital were affected in that they had to pay extra cost on loans. Here, the businesses would have to withhold or withdraw some of their future investment plans. In today’s economy, it is expected that capital budgets will thrive due to the fact that many banks and lending institutions have reduced their lending rates. I agree with the argument provided because the investments require sustainable business environment (Cromwell 1).
Bloom, Robert. “Intermediate Accounting: Management Decisions and Financial Accounting Reports.” Issues in Accounting Education 17.2 (2002): 213. Print.
Cromwell, John. “Description of Capital Budgeting.” HEARST newspapers. Hearst Communications, Inc., 2013. Web.
Falcon, Alan. “Intermediate Accounting: Management Decisions and Financial Accounting Reports.” Issues in Accounting Education 18.1 (2003): 112. Print.
Foran, Michael. “Intermediate Accounting: Management Decisions and Financial Accounting Reports.” Issues in Accounting Education 16.2 (2001): 324. Print.