Net Present Value and Capital Budgeting Process

The Company should maximize on cash management by capital rationing on the project accepted. NPV of the project should be implemented as it reflects the time value of money invested in the accepted project. Similarly this can be further elaborated by computation of IRR of both project proposal.

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.

By computing the highest discount rate at which a project will have a positive NPV, the IRR method is supposed to assure that the actual rate of return on an accepted project is higher than the required rate of return.

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.

d) Is the Internal Rate of Return (IRR) of the project greater than, equal to, or less than the cost of capital (discount rate)?

As a financial manager three major decisions are to be made which are investment, financing, and dividend decisions (Pujari, S 2015). When decisions are made in investments financial managers carefully select fixed assets also known as capital budgeting decision or current assets in which funds will be invested by the company (Pujari, S 2015). There are factors that affect the investment and capital budgeting decisions such as cash flow of the project, return on investments, risks involved, and investment criteria. For the cash flow of the project the company invests a huge amount of funds in an investment proposal it is expected to sustain a regular amount of cash flow to meet the daily requirements (Pujari, S 2015).  The amount of cash

Picking a risk factor equal to the average discount rate. Reducing the NPV by 10 percent for risky projects.

As seen in Exhibit I below, the project’s cost of equity (COE) is calculated to be 13.487%. We found this value by using the Capital Asset Pricing Model (CAPM) formula by adding the treasury note yield with the beta value, then taking the market return rate and subtracting the treasury note yield. We then multiply those values together to attain the cost of equity value of 13.487%. This means

Capital budgeting risk can be measured from three perspectives. First, the project standing alone risk, is a project’s risk ignoring the fact that much of this risk will be diversified away. Secondly, would be the project’s contribution - to - firm risk, which is the amount of risk that the project contributes to the firm as a whole, thus, considering the fact

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.

It is important to first note that since NPV is the preferred choice of examining a project here at BBI, we can agree that accepting a project that generates a positive NPV will benefit stockholders (greater return) as well as increase the overall value of the firm (Ross et al., 2014). Additionally, it is also essential to supplement our findings by computing our internal rate of return (IRR), which produces the return of a project without any external factors included (Ross et al., 2014). However, the determining

Internal rate of return (IRR) – The IRR of an investment project is the compound annual rate of return on the project, given its up-front costs and subsequent cash flows. A project’s IRR is the discount rate that causes the net present value

While in table 2 is illustrated, where the additional value from an increased leverage is going, we now have a closer look at where the change in value is coming from. For this purpose, we divide the free cash flow of the firm into pure business flows and cash flows resulting from financing effects and discount them at a consistent rate reflecting the cash flows’ risk.

The management of cash is essential to the survival of any organization. Managing an organization’s financial operation requires knowledge of the economy and ways to maximize revenue. For any organization to operate on a daily basis adequate cash flow is required. Without cash management the organization will be unable to function because there is no cash readily available in case of inconsistencies in the market. Cash is also needed to keep the cycle of the company’s operations going.

The internal rate of return (IRR) and the net present value (NPV) techniques are 2 investment decision tools that satisfy the 2 major criteria for the correct evaluation of capital projects. This criterion is that the techniques should incorporate the use of cash flows and the use of the time value of money. This makes them viable techniques for evaluating investment proposals.