If a company was planning to invest in a factory to manufacture microprocessor chips for personal computers, the process to determine the soundness of the investment would start with management forecasting a series of cash outflows for purchasing the manufacturing facility and paying product manufacturing expenses. Management would also forecast a series of cash inflows relating to product sales.
The procedure for estimating the viability of the investment would be to compare the present value of the cash inflows with the present value of the cash outflows, and if the present value of the inflows is greater than the present value of the outflows, then the investment would be advisable.
Discuss two of the following issues relating to the above scenario in terms of the time value of money concepts discussed in the chapter.
- What would be the timing or pattern of the major expenditures for financing the cost of the factory and paying product manufacturing expenses and how would they compare with the timing of cash inflow from product sales? In terms of time value of money concepts why would timing be important?
- Discuss the competitive and economic risk factors management should consider in selecting an interest rate for figuring the present value of the cash inflows and cash outflows.
- Since management would be putting money at risk by investing in this factory, they would want a reasonable rate of profit return on the investment. Select one of the following issues, then discuss the factors management should consider relating to that issue in terms of the time value of money concepts discussed in the chapter.
The time horizon over which the investment would be profitable? (Whether we like it or not, all good things come to an end.)
The payback period or investment cost recovery period? (The very first objective of any investment is not to lose money.
The risks involved in this investment for determining a desired rate of return? (There may be a hazard out there we don't know about.)