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NPV Calculation for funded asset

Our business is looking to acquire some machinery costing circa £550k. This will allow us to vertically integrate our supply chain and achieve an improved margin, and thus annual savings on our existing supply.

I would like to represent all of this in a NPV calculation. However, within the £550k we would anticipate this to be funded by an asset lender, with perhaps a £100k deposit from our own cash flow.

I am currently stuck on how best to present this. Part of me thinks I should only account for the £100k cash outflow in Year 0 and then show financing repayments and annual savings each year thereafter, for say a 5 year period. However, I also believe I need to show the full cost of the investment in Year 0 and then reflect the cost of financing in the discount factor for each year as clearly showing the full cost of investment and then financing repayment is double counting. 

The latter doesn’t sit right with me as it should be purely based on cash flows and clearly we are not paying out £550k in full at the outset.

Would appreciate any sensible advice on how best to present this?

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28th Nov 2018 17:20

Your first response is correct, the repayments will be increased in nominal terms due to the interest charged, you then discount all nominal cashflows (income and expenditure) back to PV by using the discount factor

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28th Nov 2018 17:21

This confirms what little I can remember:

https://www.icas.com/education-and-qualifications/back-to-basics-net-pre...

"2. Any financing cash flows should be excluded from the NPV analysis.

Do not include cash flows that relate to debt or equity payments or receipts. This includes loan capital receipts and repayments, loan interest payments, overdraft interest payments, dividend payments, share issues and buybacks."

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28th Nov 2018 19:03

Thanks for the replies. This is what I am struggling with. If I was to exclude debt/financing completely then I would simply show the initial investment of £550k and the annualised savings/costs thereafter. However, NPV should be based on cash flows and the reality is £550k isn’t leaving the business in Year 1 and from a cash flow perspective we will be making loan repayments on the acquired machinery for at least 5 years.

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By tom123
to rushfan1976
29th Nov 2018 14:43

The idea is that all investments are assessed on the cash flows they generate, separately from the financing.

Thus, you are acquiring an asset WORTH 550k, albeit using finance to buy it.

The choice of discount rate/hurdle or whatever is then based on the cost of capital to your organisation.

After all, even if you were cash rich, you would still be looking for a return on that cash.

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