Written Assignment Unit 06 PDF

Preview

Summary

University of the people MBA Managerial accounting...

Description

1

During capital project, there are different calculations that will help managers and organization to make decision on investments and to select from different alternatives. For this manufacturing company I have made some calculation to find out which project is feasible and the result is presented in to two separate tables for both options. Net present value Net Present Value (NPV) is the value of all future cash flows (positive and negative) over the entire life of an investment discounted to the present (Net Present Value .n.d). NPV analysis is a form of intrinsic valuation and is used extensively across finance and accounting for determining the value of a business, investment security, capital project, new venture, cost reduction program, and anything that involves cash flow (Net Present Value .n.d ). NPV is after all an estimation. It is sensitive to changes in estimates for future cash flows, salvage value and the cost of capital and Net present value does not take into account the size of the project (Irfanullah , 2019).

Calculation of NPV is as follows

It is easy to calculate using excel spreadsheet , because excel has built in function to do this task the formula mention above is also very easy. Net present value should be positive in order to pursue a project, since we are compering set of alternatives option two has higher NPV which tells us it is more favorable investment than option one.

Internal rate of return (IRR) The internal rate of return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments (Adam. H. 2019). The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero (Adam. H. 2019). IRR calculations rely on the same formula as NPV does (Adam, 2019). It is measure of absolute value added by a project, is a better indicator of a project’s feasibility ,because sometimes where the cash flows are unconventional i.e. there are net cash outflows

2

other than the initial investment outlay, we may get multiple results for internal rate of return (Irfanullah, 2019).

A project should only accept internal rate of return if it is less than the hurdle rate , option one has IRR less than the required rate of return this makes it infeasible project but comparing to option two the company has to go with option two. Payback Period Payback period is one of the simplest investment appraisal techniques, it is the time in which the initial outlay of an investment is expected to be recovered through the cash inflows generated by the investment (Irfanullah , 2019). Since payback period does not take into account the time value of money which is draw back since it can lead to wrong decisions (Irfanullah , 2019). It does not take into account, the cash flows that occur after the payback period. This means that a project having very good cash inflows but beyond its payback period may be ignored (Irfanullah , 2019).

The notion of pay back is how early you recover the first investment, option two has slightly lower pay back period but is almost equal not enough to make decsion.

3

Option one result of calculations

Accounting Rate of Return The accounting rate of return (ARR) is the percentage rate of return expected on investment or asset as compared to the initial investment cost (Chris ,2020). ARR divides the average revenue from an asset by the company's initial investment to derive the ratio or return that can be expected over the lifetime of the asset or related project (Chris ,2020). ARR does not consider the time value of money or cash flows, which can be an integral part of maintaining a business (Chris ,2020). It easy to calculate but it ignores the time value of money. In this case study AAR for option two is higher this indicates that option two is more favorable investment. This the formula for calculation ARR is really straight forward and easy one.

4

Option two result of calculations

Conclusion from the reading of all the four metrics option two is found to be more feasible investment the management should neglect option one and give green light for option two.

Reference Net Present Value (n.d). Retrieved from https://corporatefinanceinstitute.com/resources/knowledge/valuation/net-present-value-npv/

Adam. H. (2019, Jun25) Internal rate of return Retrieved from https://www.investopedia.com/terms/i/irr.asp

Irfanullah.J, (2019, May 24) Pay-back period Retrieved from https://xplaind.com/849768/payback-period Irfanullah.J, (2019, May 24) Internal rate of return Retrieved from https://xplaind.com/484996/irr Irfanullah.J, (2019, June 21) Net present value Retrieved from https://xplaind.com/478294/npv Chris B. (2020, Jan 28) Accounting rate of return Retrieved from https://www.investopedia.com/terms/a/arr.asp...