What is the payback period on each of the above projects? Given that you wish to use the payback rule with a cutoff period of two years, which projects would you accept? Why? If you use a cutoff period of three years, which projects would you accept? Why?
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
NVP Projects Discussion Question - CLO 1, 2, 4, 5
- What is the payback period on each of the above projects?
- Given that you wish to use the payback rule with a cutoff period of two years, which projects would you accept? Why?
- If you use a cutoff period of three years, which projects would you accept? Why?
- If the
opportunity cost of capital is 10%, which projects have positive NPVs? How do you know? - “If a firm uses a single cutoff period for all projects, it is likely to accept too many short-lived projects.” Is this statement true or false? How do you know?
- If the firm uses the discounted-payback rule, will it accept any negative
NPV projects? Will it turn down any positive NPV projects? How do you know?
| Project | C0 | C1 | C2 | C3 | C4 |
| A | -5000 | +1000 | +1000 | +3000 | 0 |
| B | -1000 | 0 | +1000 | +2000 | +3000 |
| C | -5000 | +1000 | +1000 | +3000 | +5000 |
Consider the cash flows for the following three projects: A, B, and C.
- If the opportunity cost of capital is 11%, and you have unlimited access to the capital, which one(s) would you accept? Why did you answer the way you did? Would your response change if the cost of capital is 16%? Why or why not?
- Suppose that you have limited access to the capital and you need to choose only one project. Which one would you choose and why? The discount rate is still 11%.
- What is the payback period of each project? Please analyze if, in general, a decision based on payback is consistent with a decision based on NPV.
- What are the
internal rates of return (IRR) on the three projects? Does the IRR rule in this case give the same decision as NPV? How do you know? - If the opportunity cost of capital is 11%, what is the profitability index for each project? Please analyze if, in general, decisions based on profitability index are consistent with decisions based on NPV.
- What is the most generally accepted measure to choose between the projects? Please justify your answer.
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- What are the
internal rates of return (IRR) on the three projects? Does the IRR rule in this case give the same decision as NPV? How do you know? - If the
opportunity cost of capital is 11%, what is the profitability index for each project? Please analyze if, in general, decisions based on profitability index are consistent with decisions based on NPV. - What is the most generally accepted measure to choose between the projects? Please justify your answer.
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