Capital Consumption Allowance

1) Calculating the Present Value

The amount of cash today that is equivalent in value to a payment, or to a stream of payments, to be received in the future. To determine the present value, each future cash flow is multiplied by a present value factor. For example, if the opportunity cost of funds is 10%, the present value of $100 to be received in one year is $100 x [1/(1 + 0.10)] = $91.

http://financial-dictionary.thefreedictionary.com/present+value

PV = CF x [ 1 ÷ (1 + r)n ]

Year

Cash Inflow

Cash outflow

Net Cash Flow

Present Value

0

(100,000)

(100,000)

(100,000)

1

82,000

(57,200)

35,600

24,800

2

90,000

(57,200)

43,600

32,800

3

86,400

(57,200)

40,000

29,200

4

83,520

(57,200)

37,120

26,320

5

81,216

(57,200)

34,816

24,016

6

79,373

(57,200)

32,973

22,173

7

77,898

(54,608)

31,498

20,698

8

81,718

(57,200)

35,318

24,518

2) Affects of the Capital Consumption Allowance

The Capital Consumption Allowance (CCA) is the percentage of the Gross Domestic Product (GDP) which is due to depreciation. The Capital Consumption Allowance measures the amount of expenditure that a country needs to undertake in order to maintain, as opposed to grow, its productivity. The CCA can be thought of as representing the wear-and-tear on the country's physical capital, together with the investment needed to maintain the level of human capital (eg to educate the workers needed to replace retirees).

According to definition The Capital Consumption Allowance should affect company`s Cash Inflow and it helps rose up to the net cash flow .I have separated tax and earnings from each other so I found cash out flow 50,000+7,200 = 57,200 and cash inflow has changed according to CCA-Earning Before Tax and Revenues Rates. If I would not make those calculations total Present Value factor will be lower than expected also that might affects the LSC Corporation`s Investment decisions as well .I am going to analyse that investment decisions deeply at 3th part of this assignment

3 Net Present Value and investment Decision For LSC Corporation

Difference between the present values (PV) of the future cash flows from an investment and the amount of investment. Present value of the expected cash flows is computed by discounting them at the required rate of return (also called minimum rate of return). For example, an investment of $1,000 today at 10 percent will yield $1,100 at the end of the year; therefore, the present value of $1,100 at the desired rate of return (10 percent) is $1,000. The amount of investment ($1,000 in this example) is deducted from this figure to arrive at NPV which here is zero ($1,000-$1,000). A zero NPV means the project repays original investment plus the required rate of return. A positive NPV means a better return, and a negative NPV means a worse return, than the return from zero NPV. It is one of the two discounted cash flow (DCF) techniques (the other is internal rate of return) used in comparative appraisal of investment proposals where the flow of income varies over time. http://www.businessdictionary.com/definition/net-present-value-NPV.html NPV = CF0 + CF1/(1+r) + CF2/(1+r)2 + CF3/(1+r)3 ...

NPV = CF0 + PV1 + PV2 +....

NPV = (100,000) + 24,800 +...+ 24,518

NPV = 39,055

At the end of calculation results I have found positive NPV. According to definition of NPV that we can invest in this project. Because definition says If NPV result positive project should accepted and if NPV result negative at that time project should rejected by the investors. But most of former financial advisors are advice to check payback period for make healthy and strong decision. Next part of this assignment you will find Payback calculation for this project

Year

Present Value

0

(100,000)

1

24,800

2

32,800

3

29,200

4

26,320

5

24,016

Pay Back:

LSC Corporation can receive the money which they spend for investing a new machinery back after 4 years and 6 months later .This is another good reason to accept that this project .If machinery works properly at all during those 8 years period company can make good profit ,and share holders knows they will earn their money in very short time period

References

1. http://www.businessdictionary.com/definition/net-present-value-NPV.html

2. http://financial-dictionary.thefreedictionary.com/present+value

Bibliography

3. http://moneyterms.co.uk/npv/

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