Caledonia Products Essay

Internal Rate of Return is a discount rate in which the net present value of an investment becomes zero. The investment should be accepted if the IRR is not less than the cost of capital. The IRR measures risk, by showing what the discounted rate would have to reach to lose all present value. Futronics Inc. investment would have an IRR of 14.79%. The investment should be accepted since it is greater than the 8% cost of capital. The 14.79% IRR shows the growth expected from the

Students may be familiar with the classic NPV criterion. This case invites them to focus on the internal rate of return (IRR). If the IRR is greater than the project cost of capital, the 7E7 is a positive net present value project.1 A discussion of why this is true provides a solid “big picture” foundation for the case decision. The project IRRs are presented in case Exhibit 9. Therefore, the focus of student analysis should be on determining the benchmark against which to evaluate the IRRs. Thus, this part of the discussion helps to motivate the analysis of WACC. Some students may have voted in a manner that contradicts the IRR versus the cost of capital decision rule. This sets up the next question.

Caledonia Products is considering undertaking a new investment opportunity. There is an initial working capital requirement of $100,000, which will be required to get the project started. To calculate the NPV of the new investment one must first calculate the cash flow for each year. It is estimated the cash flow for the following years are:

The valuation method for the project is forecasting the future free cash flows generated from the project and calculating its net present value (NPV). This project has a positive NPV of $936,147, and an

• Use sensitivity, scenario, and break-even analyses to see how project profitability would be affected by an error in your forecasts;

NPV is the difference between the present value of an investment project’s cash inflows and the present value of its cash outflows.

INVESTMENT DECISION AND CASH FLOWS A positive net present value (NPV) is a direct estimate of value creation for shareholders and is an operational way of carrying through on the strategy of trying to maximize shareholder wealth. To calculate NPV, however we need to estimate the cash costs and benefits of any decision at hand. In this note we discuss the evaluation of investment proposals.

The Internal Rate of Return (IRR) is that discount rate providing a net value of zero for a future series of cash flows. The IRR and Net Present Value (NPV) are used to decide between investments to select what investment should provide the most returns.

The following paper analyzes a project from financial perspectives using the capital budgeting techniques like Net Present Value (NPV) and Internal Rate of Return (IRR).

Internal Rate of Return is the discount rate that NPV become zero. It will accept the project that has a greater discount rate compare to IRR. It is usually used because it is easy for manager to find out the rate of return. But it is no accurate when the project have some non-normal cash flow or when evaluating mutually exclusive projects.

It is easy to understand and calculate, but it ignores cash. PB measures the number of years required so that the estimated returns can cover the initial outlay. It is also easy and simple to use, but it takes no account of cash flow after payback period. Both methods take no consideration of time value of money. To overcome those problems resulted from ARR and PB so as to make optimal decisions, the project appraisal process needs to consider the time value of money. Expected future cash flow of potential investments shall be discounted and added together to derive a lump sum of the present value using a given discount rate. Three types of discounted cash flow are NPV, IRR and PI. NPV is the difference between sum of present value and initial outlay for the proposed investment. A positive NPV indicates that the proposed investment is accepted and vice versa. NPV takes account of the time value of money and all relevant cash flows over the life of the project. However, it is difficult to understand and rely on to provide an available appropriate discount rate. IRR is the discount rate at which NPV is zero. If IRR is greater than the cost of capital, then the potential investment is recommendable. IRR is easy to understand and it excludes the drawbacks of ARR and PB that both ignore the time value of money. However, IRR often gives an unrealistic rate of return unless the calculated IRR is a reasonable rate for

NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also

Return of Investment (ROI): It is the ratio of net cash receipts of the project divided

NPV is defined that the discrepancy between the present value of an investment or project’s costs and the present value of its benefits. When the present value of benefits greater than the present value of costs, the NPV is positive, which means the investment opportunity should be undertaken, as the decision could increase the value of the investor. When the present value of benefits less than the present value of costs, the NPV is negative, which means the investment should be rejected, as accepting the project would shrink the value of the investor. NPV is one of the most accurate and reliable valuation principles, and is regarded as the ‘golden rule’ in financial decision making. The NPV rule is considered superior and is widely employed, especially by the large-size enterprises (Pasqual, Padilla & Jadotte, 2013). when NPV rule contradicts with alternative rules, always making decision based on the NPV rule.

Internal rate of return overestimates the yearly equivalent rate of return for a project whose interim cash flows are reinvested at a rate lower than the calculated IRR. IRR doesn’t consider cost of capital, it should not be used to compare projects of different duration. IRR may have