Business Finance Written Assignment

To make the most informed decision the IRRs and payback periods of the projects should be compared in conjunction with the NPVs of the two projects. The NPV analysis of the two projects under consideration indicates that the MMDC Project is the better of the two projects.

NPV analysis uses future cash flows to estimate the value that a project could add to a firm’s shareholders. A company director or shareholders can be clearly provided the present value of a long-term project by this approach. By estimating a project’s NPV, we can see whether the project is profitable. Despite NPV analysis is only based on financial aspects and it ignore non-financial information such as brand loyalty, brand goodwill and other intangible assets, NPV analysis is still the most popular way evaluate a project by companies.

Finally, in order to complete a more accurate comparison between the two projects, we utilized the EANPV as the deciding factor. Under current accepted financial practice, NPV is generally considered the most accurate method of predicting the performance of a potential project. The duration of the projects is different, one lasts four years and one lasts six years. To account for the variation in time frames for the projects and to further refine our selection we calculated the EANPV to compare performance on a yearly basis.

ii. The project should be accepted if the NPV is positive because such a project increases shareholder value.

The NPV calculation provides a dollar measure of how much a project is expected to add to a firm 's value. Analysts may also want to know what the rate of return on a project is in order to compare it to the cost of capital. This rate is called the internal rate of return, or IRR.

Thus, by year three the company will be making a profit off the investment as year three is 86.73 million profit by 55.35 cost giving the company a 31.38 million dollar surplus. Generally, a period of payback of three year or less is acceptable (Reference Entry) causing this project to be viable based off the payback analysis. Although, these calculations are flawed. The reason for this is because the time value of money is not taken into effect when calculating payback periods which is where IRR can further assist in a more realistic financial picture (Reference Entry).

Using the IRR method will result in project Q being selected over P due to its higher rate of return. Using the NPV method would result in choosing project P because of its higher NPV. When there are mutually exclusive project, NPV method would be preferred.

26.8 B. Ex. 26.9 B. Ex. 26.10 Topic Understanding payback period Use of return on investment Comparing NPV and required rate of return Net present value computations Computations for payback period Capital investment challenges Net present value and required rate of return Capital budgeting behaviors Net present value analysis Nonfinancial investment concerns Exercises 26.1 26.2 Topic Accounting terminology Payback period 26.3 26.4 26.5 26.6 26.7 26.8 26.9 26.10 26.11 26.12 Learning Objectives 26-3 26-3 26-3, 26-4 26-3 26-3

There are two methods which is applied to this project. First is by calculating net present value and second is by using Internal rate of return (IRR). Also, it determines how many years that Riverlea earns back from its investment if they take this project. This is called payback period.

It could also change our decision to go for one or the other project, especially if the NPV values are close to one another.

3. The NPV method is better because it shows the size of the project so you can see how much value a project has not just a percentage. You could have a higher percentage but a much lower value and you would still go for the lower percentage.

In this method the following factors have much importance and that they affect the results of the NPV. Such factors are;

When using NPV to determine whether or not to invest in a project, the general rule is to accept the project if NPV > 0 and reject if NPV is negative (or zero). The NPV for the proposed NBC contract is, as seen in table 4 is £137,350.26. On this basis NPV the contract does appear a positive investment. To investigate this further the internal rate of return is calculated below.

Profitability index (PI) and net present value (NPV) is two parameters that use in an investment. However, there are specific differences among them. In fact the, profitability index is considered to be less advantageous than net present value method this is because profitability index has its limitation which is more when compared to net present value.

Techniques such as payback period, accounting rate of return (ARR), net present value (NPV), profitability interest (PI) and internal rate of return (IRR) are the traditional techniques used to evaluate or appraise capital investment project.