Evaluating a firm’s projects is key for the success of the firm (Brigham, Ehrhar

Question

Evaluating a firm’s projects is key for the success of the firm (Brigham, Ehrhardt 2015). The net present value (NPV) is how that is calculated to justify the value of a project from the beginning. An issue with the calculated NPV is that the equation uses expected net cash flows. A high expected net cash flows can push the NPV up beyond the true value of the project. Something that looks to be trending up could have produced a false sense of security when producing the expected results.

A project starts with the rate thought to be 12%, but after unexpected costs due to systems that needed additional updates to run the project the rate is now 10% in just the first year alone. The project is already at a lower net present value than what was assumed. With project management, you do not want to overbudget by too much and you do not want to underbudget by too much, but you always need to leave a little buffer room. This project might have been deemed as a potential money maker from the get go and now may only break even depending on the initial costs.

***Please make a response to the above discussion post**

150 word and no plagiarism.

Explanation / Answer

It is quite true that NPV uses expected cash flow. A reasonable estimation of cash flow is required for correct NPV picture of the project. Cash flow should be factored for all the probabilities and sensitivity analysis should also be carried to arrive the NPV in case any of the parameter changes.

Once decision has been taken basis NPV then work is not over, project should be monitored continuously and comparison of expected v/s actual cash flow should be done. At any point in time the actual return are below required return it should be analysed and decision should be taken for continuation of the project.

Its always good keeping buffer but same time it should not be over budgeted. If the project is on break even and has potential of good return still it can be continued.

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