A project namely as Bisham came up by Virgin Media Inc Essay

A project namely as Bisham came up by Virgin Media Inc - Essay Example The paper tells that investment appraisal techniques basically work on the basis of incremental cash flows and not on the basis of net income. Incremental cash flows are the additional cash flows that a firm generates by investing in a particular project, thus the cash flows being generated from that project are added to the projected net income of the firm. However, in order to ensure whether a certain project is viable for the firm or not, the decision lies on the overall net cash flows pertaining to that project. The net cash flows of a particular project can be obtained by subtracting the net income of the company without accepting a project, from the net income of the firm with accepting a project. The basic formula for the incremental cash flows of a particular project is: Net cash flows of the project = Net Income of the company with the project - Net Income of the company without the project The reason behind using incremental cash flow approach in investment appraisal techniques is that it clearly states the actual cash outflows and inflows of a particular project. In case, when a firm has more than one projects and the firm has to decide which project needs to be opted, at that time this incremental approach assists the financial managers of the company, as the overall net income of the company might increase with every project, but the incremental cash flow approach clearly distinct between every project and their viability. As a result, the incremental approach is more useful in appraising different projects. ... These difficulties are as follows: Future projection of cash flows is subject to judgment of the financial analysts which vary with person to person. Inflation rate is subject to unpredictability as local economy as well as global economy may perform either way. The decision of operating cash flows are subject to pure judgment as nobody knows about the cost of direct material, future wage rates and above all the factory overheads estimates during the project life. The tax rate may change due to change in government’s policy. The working capital requirements are subject to pure judgments as to how to estimate them and the assumption regarding their reversal in the last year of the project. Net Cash Flows of Project Bisham under current conditions The following are the net cash flows of the project Bisham for 8 years project life. Yrs 0 1 2 3 4 5 6 7 8 NCF (1,400,000) 199,700 334,000 317,125 304,469 294,977 287,857 282,518 398,514 In the above table, year 0 indicates the year in which the initial investment is made in the project in the form of purchasing of two machineries naming as Machinery A and B for $1,200,000 and $200,000 respectively. The other figures included in the net cash flows from year 1 to year 8 are derived in such a manner that operating cash flows are computed first. Cost per unit of the product is first calculated by adding up per unit cost of each material, labor and factory overhead. Then these variable costs are deducted from the selling price per unit to obtain the contribution per unit. Contribution per unit for each year is then multiplied by the total number of units to be produced and sold each year to obtain