The Formula Of Net Present Value: Discounted Cash Flows

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Since money has time value in every economy, so evaluating cash flows which were generated from some periods requires a procedure. The discounted cash flow provides a rational technique to calculate a present value which might help in adjusting the future cash flows to depict the fact that money planned to receive in future features lesser worth than what is being received at present. Its analysis involves the use of future free cash flow and discounts them to find the present value, which is then used to calculate the potential for investment. The formula of Net Present Value is as follows:
For the company, to make a decision among the three investment options, it is important to consider that the value reached at through the discounted cash
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Overall, all options have NPV of cash flows that greater than zero. It indicates that this is a valuable project with option 1 as the most reasonable investment since it has the greatest NPV at AUD 167.59 million, followed by option 2 and option 3 which account for AUD 161.59 million and AUD 142.59 million respectively. With the promising value of NPV, it is not surprising that the palm oil industries in Indonesia grow very fast over the past 2 decades.
Another method of investment appraisal is the Internal Rate of Return (IRR). It is the discount rate that, when applied to its future cash flows, will produce a NPV of precisely zero. The IRR for this project is better than average or exceeds the company’s cost of capital. It indicates that investment in this project is profitable. Based on the calculation in table 5, option 1 by far has the biggest IRR which stood at 49% followed by option 2 (47%) and option 3 (39%).
The value of NPV above only gives a big picture form the time value of money perspective. To make a financial decision in the investment, the company should consider the risk which might occur in each option. Generally, every risk that occurs has potency to escalate the project cost. This could lead to a significant change in the NPV above and also change the options’
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This situation has brought risk to escalate the cost particularly on the opening land expense. The probability for this issue itself is more than 75 %, indicating the almost certain likelihood. Furthermore, the availability of land is also limited, adding difficulty to achieve the new 20,000 hectares plantation. This risk could be classified to the moderate level in both likelihood and consequence. In fact, there are so many theft cases in this island that lie in likely to happen with low consequence.

Option 2
The main problem in option 2 is the bushfires which could damage the plantation, put the project far behind schedule and increase the project cost. This situation occurs only when ‘el nino’ comes to Indonesia. It is likely to happen and has extreme consequence since it would decrease the CPO production which leads to a failure to achieve 174,000 ton CPO per year. Furthermore, it is difficult for the company to legalize their land that might lead to some disputes in the future. Even though it is unlikely to happen, but the consequence is quite high. This is because the conflict would be taken to the court and need extra cost and longer time. In addition, if the company defeated in the court, then the project has to be stop

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