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Net Present Value Final
Net Present Value Final
The firm
has two projects in hand; Project A & project B. The expected cash flows are also given.
Requirements
We know,
NPV:
Net Present Value (NPV) measures the viability of a project or investment by taking into
account the investments (outflow) and returns generated (inflow) from the investments. It is
computed based on the sum of a series of cash flows in and out. NPV takes into account the
series of cash paid or received in today’s value. This is different from a layman calculation of
cash flows which only takes into account the dollar value of the cash flows.
( http://www.advanced-excel.com/net_present_value.html)
NPV Formula:
Accept-Reject Criteria
According to this method any project with a positive NPV will be accepted and projects with a
negative NPV will be rejected. In other words, if present value of cash inflows is greater or equal
to present value of outflows, than the project will be accepted and rejected if not. Then again, in
case of mutually competitive projects the project with the greater positive NPV should be
selected while rejecting the rest. In order to make it easier projects are ranked according to
greater positive NPV. (M.S. MINA, (2006) Fundamentals of Finance)
IRR:
The discount rate often used in capital budgeting that makes the net present value of all cash flows from a
particular project equal to zero. Generally speaking, the higher a project's internal rate of return, the more
desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a
firm is considering. Assuming all other factors are equal among the various projects, the project with the
highest IRR would probably be considered the best and undertaken first.IRR is sometimes referred to
as "economic rate of return (ERR)".( http://www.investopedia.com/terms/i/irr.asp)
IRR Formula
Accept-Reject Criteria
According to IRR method the projects with IRR greater than all the project’s cost of capital those
will be accepted and rest rejected. In case of mutually competitive projects the project with the
greater IRR will be accepted. In general the acceptable projects are ranked in a descending
manner determined by IRR value, and then the projects can gradually be selected from greater
IRR to less. (M.S. MINA, (2006) Fundamentals of Finance)
Calculation
Project A
NPV = $0
NPV = ($98.48)
NPV = ($8.7)
Recommendations
• According to the math, if it is not financially constrained, I would say, Project B and
a both could be accepted depending on the NPV, as they both show potential positive
NPV. Considering other factors it is better to undertake Project B.
• IF the company lacks the capital to undertake both projects I would say Project B is the
better option to undertake.
• The IRR results conflict with the obtained results from the NPV analysis in terms of
which project adds greater value to the firm. The analysis supports project A as more
feasible. Whereas Project A in reality is too risky and unwise.
References
Book
1. M.S. MINA, (2006) Fundamentals of Finance, 2nd Edition, Dhaka, S.N Publications.
Internet
1. M.S. MINA, (2006) Fundamentals of Finance, 2nd Edition, Dhaka, S.N Publications.p-
284,290.
Internet