Milestone Three- Whitney Lawrence

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Whitney Lawrence Southern New Hampshire University FIN 550: Corporate Financial Management 19TW4 Milestone Three July 5, 2019

IV. Capital Budgeting Data 1. Calculation of Net Present Value and Internal Rate of Return If UPS is considering a potential investment project to add to their portfolio, the NPV was calculated to be $15,404,422.60 and the IRR was calculated to be 19%. 2. What are the implications of these calculations? In other words, based on each of the calculations, and being mindful of the need to balance portfolio risk with return, would you recommend that the company pursue the investment? These calculations show a NPV of $15,404,422.60 and an IRR of 19%. Both calculations show favorable values which could be accepted as the NPV is a positive number which means potential positive cash flows and the IRR is greater than the WACC of 9% which is what we’d

want to see. Before we can provide any recommendations about whether or not the company should reject or accept the offer for this project, we need to figure out what these calculations tell us and what it means for the future of UPS. This can also be referred to as a risk-return tradeoff. “The risk-return tradeoff is the trading principle that links high risk with high reward” (Chen, 2019). 3. What is the difference between NPV and IRR? Which one would you choose for evaluating a potential investment and why? “The net present value (NPV) method discounts all cash flows at the project’s cost of capital and then sums those cash flows. The project should be accepted if the NPV is positive because such a project increases shareholders’ value” (Ernhardt & Brigham, pg. 441). The internal rate of return (IRR) is defined as, “the discount rate that forces a project’s NPV to equal zero. The project should be accepted if the IRR is greater than the cost of capital” (Ernhardt & Brigham, pg. 441). NPV and IRR differ in numerous ways such as their meanings, the way each is expressed, what they represent, decision making, rate for reinvestment of intermediate cash flows, and variation in the cash outflow timing. For example, NPV is expressed in absolute terms whereas IRR is expressed in percentage terms. NPV makes the decision making process easier whereas IRR has no impact. Instances where timing of cash flows is different, the IRR will be negative, or it may produce multiple IRR which could cause

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issues. This would not happen with NPV. As a result of my findings and understanding of the differences between NPV and IRR, I would recommend that UPS use the NPV method when evaluating potential investments. NPV is most commonly used by companies as more problems tend to arise when using IRR. “While some prefer using IRR as a measure of capital budgeting, it does come with problems because it doesn't take into account changing factors such as different discount rates” (Palmer, 2019).

References Chen, James (2019, March 28). Risk-Return Tradeoff. Retrieved from https://www.investopedia.com/terms/r/riskreturntradeoff.asp Ehrhardt, Michael C. & Brigham, Eugene F. (2017). Corporate Finance: A Focused Approach. Cengage Learning. Sixth Edition. ISBN: 978-1-305-63710-8. Palmer, Barclay (2019, February 16). Should IRR or NPV Be Used in Capital Budgeting? Retrieved from https://www.investopedia.com/ask/answers/05/irrvsnpvcapitalbudgeting.asp