Net Present Value (NPV) is used in capital budgeting to analyze the profitability of an investment or project. NPV is found by subtracting the present value of the after-tax outflows from the present value of the after-tax inflows. Investments with a positive NPV increase shareholder value and those with a negative NPV reduce shareholder value. In order to compute the NPV for Worldwide Paper Company, we have to calculate the cash flow in capital budgeting of the project as below. | | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | Terminal Cash flow | A | Fixed Assets | | | | | | | | | | Cost of Investment | -$16 | -$2 | | | | | | | | Sales of Fixed Asset | | | | | | | | $1.08 | B | Working Capital | | | | | | | | | | Incremental Sales | | $4 | $6 | | | | | | | Change in Working Capital (10%) | | $0.4 | $0.6 | | | | | | | Cash flow of investment in working capital | | -$0.4 | -$0.6 | | | | | $1.0 | C | Operating Cash Flow | | | | | | | | | | Revenue of Investment | | $4 | $10 | $10 | $10 | $10 | $10 | | - | Cost of Good Sold (75%) | | -$3 | -$7.5 | -$7.5 | -$7.5 | -$7.5 | -$7.5 | | - | SG&A expenses (5%) | | -$0.2 | -$0.5 | -$0.5 | -$0.5 | -$0.5 | -$0.5 | | | Net Income | | $0.8 | $2 | $2 | $2 | $2 | $2 | | + | Operating Saving | | $2 | $3.5 | $3.5 | $3.5 | $3.5 | $3.5 | | - | Depreciation | | $3 | $3 | $3 | $3 | $3 | $3 | | | EBIT | | -$0.2 | $2.5 | $2.5 | $2.5 | $2.5 | $2.5 | | - | Tax (40%) | | -$0.08 | $1 | $1 | $1 | $1 | $1 | | | EAT | | -$0.12 | $1.5 | $1.5 | $1.5 | $1.5 | $1.5 | | + | Add back Depreciation | | $3 | $3 | $3 | $3 | $3 | $3 | | | Total Operating Cash Flow | | $2.88 | $4.5 | $4.5 | $4.5 | $4.5 | $4.5 | | D | Total Project Cash Flow (A+B+C) | -$16 | $0.48 | $3.9 | $4.5 | $4.5 | $4.5 | $4.5 | $2.08 |
Figure 1: Worldwide Paper Company Cash Flow in Capital Budgeting (in millions).
As we can see