The net investment (NINV) in a project is defined as the project’s initial net cash outlay, that is, the outlay at time (period) 0. It is calculated using the following steps:
The calculation of the net investment for two example projects is illustrated in later sections of the chapter dealing with asset expansion and asset replacement projects. Also discussed are some of the tax consequences that can influence the net investment of a project. These tax effects are the treatment of gains and losses from asset sales in the case of replacement decisions.
If a project generates additional revenues and the company extends credit to its customers, an additional initial investment in accounts receivable is required.Moreover, if additional inventories are necessary to generate the increased revenues, then an additional initial investment in inventory is required, too. This increase in initial working capital—that is, cash, accounts receivable, and inventories —should be calculated net of any automatic increases in current liabilities, such as accounts payable or wages and taxes payable, that occur because of the project.
As a general rule, replacement projects require little or no net working capital increase. Expansion projects, on the other hand, normally require investments in additional net working capital.
Some projects require outlays over more than one year before positive cash inflows are generated. It may take several years to design and construct a new production facility, such as an automobile assembly plant. In these cases, the NINV for that project will be equal to the present value (at time 0) of this series of outlays, discounted at the firm’s cost of capital. For example, consider a project requiring outlays of $100,000 in year 0, $30,000 in year 1, and $20,000 in year 2, with a cost of capital equal to 10 percent. The NINV or present value of the cash outlays is calculated as follows:
Figure illustrates this concept.
Timeline of NINV for a Project with Multiple Period Outlays
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Financial Management Tutorial
The Role And Objective Of Financial Management
The Domestic And International Financial Marketplace
Evaluation Of Financial Performance
Financial Planning And Forecasting
The Time Value Of Money
Risk And Return On At&t Common Stock
Fixed-income Securities: Characteristics And Valuation
Common Stock: Characteristics,valuation, And Issuance
Capital Budgeting And Cash Flow Analysis
Capital Budgeting: Decision Criteria And Real Option Considerations
Capital Budgeting And Risk
The Cost Of Capital
Capital Structure Concepts
Capital Structure Management In Practice
Working Capital Management
The Management Of Cash And Marketable Securities
Management Of Accounts Receivable And Inventories
Lease And Intermediate-term Financing
Financing With Derivatives
Internationan Financial Management
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