Answer 1)
With depreciation expenses cosndiered, the cash flow for second year was $624688. However, if there were no depreciation expenses, in such case the annual cash flow would have been:
[Sales- Cash Expenses- Taxes]= $5,25,000
ii) If depreciation is excluded from the analysis, in such case this will increase the national income but will decrease the annual cash flow in the absence of depreciation.
Answer 2)
NPV Analysis is the most popular tool of capital budgeting analysis and aims at providing maximum value to the shareholders by accepting only those projects which have positive Net Present Value.
However, our calculation suggest that the project has negative NPV Factor, hence it will not be viable and ideal for the company to take up the project. Thus, the company should abandon its decision to invest in the project.
ii) The decision to abandon the investment in the project is important because if a project with negative NPV is selected this will decrease the shareholder value, which no entity would like to see.
Answer 3)
Our calculation indicates that IRR of the project= 11.822% while the weighted average cost of capital of the company is 12%. Thus, since WACC is higher than IRR, the project should be abandoned.
ii) The decision to abandon the project is importnat because since IRR is less than WACC, it will not be profitable for the company to invest in the project.
Answer 4)
IRR is a method used in Capital Budgeting Decision Making Process while ARR is a method for calculating rate for one-off payment. The primary reason or difference between IRR and AAR multiple is that IRR is a discount rate that equates the Present value of the cash flows to the NPV of the project while ARR just gives the actual accounting return although it is highly prone to manipulation because of unethical and unreal treatments transacted in Bottom Line Profits.
Answer 5)
Payback Period is one of the most simple technique of capital budgeting where it is used to ascertain the time it will take for the entity to recover its initial cash outflows from the cash inflows generated by investment project. It is an important determinant as no business organization would like to invest in projects with long payback time period.
Answer 6)
While working on NPV method, the weighted average cost of capital is used to calculate the present value factor which is then used to discount the series of cash flows. Also known as discount rate, WACC is an important component of NPV Calculation as even a small change in WACC Multiple can change the NPV results.
Answer 7)
Internal Rate of Return refers to rate when Present Value of Inflows will be equal to Present Value of Outflows. Howeevr, once the IRR Multiple is calculated, the same is comapred with WACC Multiple of the project and the project is accepted only if IRR is greater than WACC and vice versa.
Works Cited
Investopedia. (n.d.). IRR Rule. Retrieved January 16, 2014, from Investopedia: http://www.investopedia.com/terms/i/internal-rate-of-return-rule.asp
Rambaldini, A. (n.d.). The Difference Between an Accounting Rate of Return & an Internal Rate of Return. Retrieved January 16, 2014, from Ehow Money.
Robinson, T. (2011). Capital Budgeting. In C. Instiute, Corporate Finance (pp. 20-34). Boston: Custom.
