Compute Present Value
Imagine that you are the Chief Operations Officer (COO) for NCU AMC. You have been tasked with deciding whether in invest in a new piece of equipment as a capital purchase, and are considering purchasing from one of several vendors you are in active discussions with. As an incentive, one of the vendors pledges to buy back the piece of equipment in 3 years for $250,000.
Assuming a discount rate of 4%, what is the present value (PV) of the $250,000 to be received 3 years from now? Given your answer and using today’s date as the time of valuation, explain if a $1 received today is worth more or less than $1 received 3 years from now? Be sure to include the PV you derived in your response.
Consider the following information in your response:
• How do you calculate the Net Present Value (NPV)?
• Why is it important to understand the future value of money spent in the present?
• How does understanding NPV affect strategic planning and capital budgeting?
Length: 1-2 pages, not including the reference page
References: Include a minimum of 3 scholarly resources
Executive Summary: Explore Capital Expenditure Decisions
If NCU AMC deposits $130,000 today into an investment fund that is expected to grow at an annual rate of 6%, what will be the value of this investment:
1. 2 years from now
2. 4 years from now
3. 7 years from now
NCU AMC is also considering a new surgical robot system for the OR costing a total of $2,300,000 (includes installation). The expected cash flows from each year of the 5-year period is $250,000, $320,000, $350,000, $400,000 and $425,000.
• What is the internal rate of return (IRR) for the project?
• Given an interest rate of 10%, what is the Net Present Value (NPV) for the surgical robot system project?
• Considering the IRR and the NPV, would you recommend that NCU AMC purchase the surgical robot system?
• What factors need to be considered in terms of investing the money for future patient care needs compared with purchasing the robot system for current patient care needs?
• Assess the potential legal and ethical ramifications of the purchase.
Prepare a memo to the CFO that presents the calculation (a photo or scan of the formula and calculation is acceptable) and what the results of the calculation mean.
Length: 2-3 pages, not including the reference page
References: Include a minimum of 5 scholarly resources.
To calculate the present value (PV) of $250,000 to be received 3 years from now, we can use the formula for calculating present value:
PV = FV / (1 + r)^n
PV = Present Value
FV = Future Value
r = Discount rate
n = Number of periods
In this case, the future value (FV) is $250,000, the discount rate (r) is 4%, and the number of periods (n) is 3 years. Plugging these values into the formula, we get:
PV = $250,000 / (1 + 0.04)^3
PV = $250,000 / (1.04)^3
PV = $250,000 / 1.124864
PV ≈ $222,542.66
Therefore, the present value of $250,000 to be received 3 years from now, with a discount rate of 4%, is approximately $222,542.66.
A $1 received today is worth more than $1 received 3 years from now because of the time value of money. The time value of money concept recognizes that money has a potential to earn a return over time. Therefore, receiving money earlier allows for the opportunity to invest and earn returns. Additionally, there is always a certain level of uncertainty about receiving money in the future, as there are various factors that can impact its value or availability.
Understanding the future value of money spent in the present is important because it helps in making informed decisions regarding investments and capital budgeting. By calculating the present value of future cash flows, such as in the case of the equipment purchase, it allows for a comparison of the value of money received in the future with the cost of acquiring the equipment today. This analysis helps in assessing the profitability and feasibility of investment projects.
Net Present Value (NPV) is calculated by subtracting the initial investment from the sum of the present values of future cash flows. It takes into account the time value of money by discounting future cash flows to their present values. If the NPV is positive, it indicates that the investment is expected to generate more value than the initial cost, making it potentially profitable.
Understanding NPV affects strategic planning and capital budgeting as it provides a quantitative measure to evaluate investment opportunities. By comparing the NPV of different projects or investment options, decision-makers can prioritize investments that are expected to create the most value for the organization. It helps in allocating resources efficiently and maximizing shareholder wealth. NPV also helps in considering the risk and uncertainty associated with future cash flows, as a higher discount rate can be used to reflect higher risk and adjust the present value accordingly.
Brigham, E. F., & Houston, J. F. (2017). Fundamentals of financial management. Cengage Learning.
Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2018). Fundamentals of corporate finance. McGraw-Hill Education.
Brealey, R. A., Myers, S. C., & Allen, F. (2017). Principles of corporate finance. McGraw-Hill Education.
To: CFO, NCU AMC
Date: [Current Date]
Subject: Capital Expenditure Decisions – Calculation and Results
I have conducted an analysis of two capital expenditure decisions for NCU AMC and present the calculation and results below:
Investment Fund Growth:
If NCU AMC deposits $130,000 today into an investment fund that is expected to grow at an annual rate of 6%, the value of the investment will be: