The effect of Americans Recovery and Reinvestment Act (2009) on Mar’s NPV.

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The effect of Americans Recovery and Reinvestment Act (2009) on Mar’s NPV.   

Introduction

The present value (PV) is a value of future, negative or positive of cash flow. This value has to be adjusted for time value and the risk involved.NPV (Net present value) is the total of all the PVs (Present values) of each individual entry of the same type. It includes the initial cost of buying an asset whereas it’s not included in present value. The PV is very useful the cash flow that’s negative is the first one when buying stocks and securities.  It’s the net current worth of a series of time intervals of other cash flows. When future cash flows are all incoming (such as bonds and coupons) and purchase price is the only outflow of cash then the NPV  can be calculated by getting the difference of all future cash flows and the purchase price ( its PV ). In the discounted analysis of the cash flow, the NPV is a critical component and it’s also the major factor when computing the real time value of the money incurred to appraise projects that are long term. In capital budgeting, finance and economics the NPV is still used to measure and calculate extra or deficit in present values or other finance expenses. . (Khan, 1993).

NPV is affected by the rate of discounting, the time interval and the amounts involved. When the rate is very high for discounting the present value then the NPV is very low, when the rate is low then the NPV is high. Time interval also affects the NPV; the earlier the time the higher the NPV.Time intervals that are late or which come later give lower NPV.  The income involved in the analysis also determines the NPV of the company or the project. When the income is high, the NPV is also high also when the income s low so is the NPV.A minor change in the rates of discounts causes a very large change in the Net Present Value. Net Present Value in some cases can be based on uncertain forecasts of other future cashflows.These makes the figures unreliable and inaccurate. (Gordon, 1962).

One solution to this problem is to use a range of NPV values using different but many discount rates and forecasts, so as to have a variety of choices i.e. the best, median or the worst case numbers for NPV values. Probability distribution can also be used for NPV. (E.g. Monte- Carlo method)

a). Explain how the Bonus Depreciation change would affect the NPV of Mar’s computers.

Depreciation refers to the decrease in value of an asset i.e. depreciation of fair value to cover its future replacement after its working life is over. Depreciation also refers to the cost allocation of assets to the period the assets were used. When assets depreciate, the balance sheet is affected as the capital assets have reduced their value. Whereas when cost is allocated to the periods they were used then the net income is affected.

The bonus depreciation change allows first year depreciation of 50% of the cost of the asset. Depreciation expense is generally reserved for future replacement of the asset. It’s a kind of saving i.e. it’s like income. The Bonus depreciation will affect the NPV in two ways. A), as an income B. Time interval. . (Khan, 1993).

When income increases so does the NPV; Increase in allowance for depreciation up to fifty percent will also reduce the tax burden for most companies. Also when the statutes allow the fifty percent charge on depreciation to be claimed initially increases the NPV because it increases with time the sooner the income the higher the NPV and vice versa

  1. b) Explain why the Extended Loss Carry backs for small business would not have an impact on the NPV of a project.

The Extended loss carry backs allowed companies to claim losses for up to five years beginning 2008. This would not have any effect on NPV because they are losses which have already passed through the financial year and the company’s are trying to recover some of the losses incurred.

  1. c) How would this Act alleviate potential credit woes for businesses and influence bond yields in long-term

.           The bonus depreciation change will definitely subsidize the emerging and developing companies to recover some earnings from major capital investment as recouping fifty percent of depreciation in the first year is a big step towards rejuvenating small and ailing companies. A bond is a loan raised in the public market. Its interest is fixed and doesn’t participate in company profits.

Yield is an amount that shows the actual returns one gets on a bond. Yield can be calculated using the following formula, Yield = amount on coupon/Price. When bonds are bought at par, yields equal the rate of interest. Yield changes in accordance with the price.

The American Recovery and Reinvestment Act of 2009, is an economic stimulus package designed to revamp the companies that were at the mercy of the economic hardship. It takes a long time for companies to go through the business cycle and start making profits again but once the companies start making profits then prices of the bonds will definitely go down as the demand for bonds will go down. These will again create more demand for the Bonds as the demand will rise because of the low prices. The Bonds yield and price are related inversely.  In the long run, the ailing companies will recover and the bond market will stagnant as the firms will no longer need to raise money by issuing bonds.

NPV indicates the amount and value an investment earns for the firm. The decision to use a particular discounting rate and the interval is critical and it affects the NPV.

References.

Gordon, M. (1962). The Investment, Financing, and Valuation of the Corporation. Homewood:  D. Irwin

Khan, M. (1993). Theory & Problems in Financial Management. Boston: McGraw Hill

Higher Education.

Vance, D. (2003). Financial analysis and decision making: tools and techniques to solve

 financial problems and make effective business decisions. New York: McGraw-Hill.

 

 

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