Financial Management Assignment Help

Financial Management Assignment Help

Financial Management Assignment Help

This is the solution of financial management assignment help in which we discuss net present value for profit calculation and consider cash flow on inflation and deflation

Project SQ

Years

Cash Inflow

Cumulative

P.V. Factor

Present Value

1

250,000

250000

0.901

225250

2

200,000

450000

0.812

162400

3

170,000

620000

0.731

124270

4

150000

770000

0.658

98700

5

130000

900000

0.593

77090

6

130000

1030000

0.535

69550

 

 

 

 

757260

Project HT

Years

Cash Inflow

Cumulative

P.V. Factor

Present Value

1

170,000

170000

0.901

153170

2

180,000

350000

0.812

146160

3

200,000

550000

0.731

146200

4

250000

800000

0.658

164500

5

300000

1100000

0.593

177900

6

550000

1650000

0.535

294250

 

 

 

 

1082180

Net present value (NPV), its acceptability and decision.

Net Present Value
Preset value of cash inflow - Preset value of cash outflow
Project SQ
757,260 – 670,000 = 87,260
Project HT
1,082,180 – 940,000 = 142,180

Net present value is the technique that calculates profit of whole project undertaken in real terms. Net present value considers cash inflows at discount rates. Present value of cash outflow is reduced from present value of cash inflow in order to arrive at net present value of project (Badie, 2000). Projects having positive NPV can be selected and projects having negative present value shall not be considered.

Advantage
it considers inflation factor in cash flows and it is easy to calculate and understand.

Disadvantage
Projects having different life then NVP cannot used to make selection decision.

Decision:In present case there are two projects undertaken and both having same life therefore project having highest NVP shall be selected. Project HT NPV is $ 142,180 and project SQ having NPV of $ 87,260. Therefore project HT will be selected.

Pay Back Period (PBP), acceptability and decision.

Project SQ
Payback Period= 3 + (670,000 – 620,000) ÷ 150,000 = 3.33 years

Project HT
Payback Period= 4 + (940,000 – 800,000) ÷ 300,000 = 4.47 years

Payback period is the period that denotes the period within which initial investment of project will be recovered (Badie, 2000). Payback period denotes recovery period and will become base for the decision making process in terms of time required to recover initial cost. Projects having low payback period shall be accepted because it denotes when initial cost of project will be recovered.  

Advantage
Payback period is used for decision making when company is requires and company wants to recover its initial cost in quick session.

Disadvantage
Payback period does not consider post recovery profitability of projects and it does not present correct decisions i.e. it does not consider inflation rate.

Decision:Project SQ having payback period of 3.33 years and project HT having payback period of 4.47 years. Therefore project SQ shall be selected because its cost recovery rate is more than project HT.

Internal Rate of Return (IRR), Acceptability and Decision.

Project SQ

Years

Cash Inflow

P.V. Factor @ 11%

Present Value

P.V. Factor @ 17%

 

Present Value

1

250,000

0.901

225250

.855

213750

2

200,000

0.812

162400

.731

146200

3

170,000

0.731

124270

.624

106080

4

150000

0.658

98700

.533

79950

5

130000

0.593

77090

.456

59280

6

130000

0.535

69550

.390

50700

 

 

 

757260

 

655960

IRR = 11 + (757260 – 670,000) ÷ (757260 – 655960) x 17 – 11
11+ (1.130 ÷ 1.154) x 6
16.87%

Project HT

Years

Cash Inflow

P.V. Factor @ 11 %

Present Value

P.V. Factor @ 16

Present Value

1

170,000

0.901

153170

0.862

146540

 

2

180,000

0.812

146160

0.743

133740

 

3

200,000

0.731

146200

0.64

 

128000

 

4

250000

0.658

164500

0.552

 

138000

 

5

300000

0.593

177900

0.476

 

142800

 

6

550000

0.535

294250

0.41

 

225500

 

 

 

 

1082180

 

914580

 

IRR = 11 + (1082180 – 940,000) ÷ (1082180– 914580) x 16 – 11
11+ (0.84833) x 5
15.24%

Internal Rate of Return is the return which is actual rate of return that any project or investment fetches. IRR is the break even rate at which present value of cash inflows is equal to present value of cash outflow of particular project. Internal Rate of Return considers inflation factor or discount rate at which project is taken. At Internal Rate of Return point net present value of project will be nil (Hammond, 1999). Internal Rate of Return is the rate that shall be fetched by investment or project i.e. at least that rate shall be achieved from investment or project.

Advantage
It is the actual rate that project fetches at break-even point or at zero level. Internal Rate of Return considers inflation rate or discount factor that will adjust inflation in market in cash flows of project.

Disadvantage
Internal Rate of Return doe not because base for mutually exclusively projects i.e. whose investment amount cannot be change or modified. It requires complex calculation.

Decision:Projects having minimum Internal Rate of Return shall be accepted because low Internal Rate of Return implies recovery of cost invested in project. Decision can be on the basis of lower of IRR i.e. management desired rate of return and IRR. If IRR is lower or equal to that desired rate then project shall be accepted otherwise not.

In this case project HT having Internal Rate of Return of 15.24% and project SQ having Internal Rate of Return of 16.87%. Therefore on the basis of above criteria project Ht shall be selected because it will be able to recover cost more quickly as compared to project SQ.

Profitability Index (PI), acceptability and decision.

Profitability Index (PI) = Present Value of Cash Inflow / Present Value of Cash Outflow

Project SQ
Profitability Index (PI) = 757,260 / 670,000 = 1.13

Project HT
Profitability Index (PI) = 1082180 / 940,000 = 1.15

Profitability Index is basically ratio that calculates relationship and nature of relationship between present values of cash inflow and present value of cash outflow. Project having profitability index as 1 it implies that present value of cash inflow and present value of cash outflow is same (Arnold, 2005). Profitability Index is used to rank projects on the basis of per unit value created in investment or project.

Advantage
It considers present value factor and used to rank project on the basis of value of investment i.e. unit wise value of investment.  

Disadvantage
it does not provides criteria for selection of project it only ranks them.

Decisions:Projects SQ having PI of 1.13 and project HT having PI of 1.15. Ranking can be given to mutually exclusive project. According to PI project HT will be ranked as first and project SQ will be second.

Mutually exclusive projects - Recommendation with reasons

Mutually exclusive projects are those projects under which acceptance of one project will impact cash flows of another project. Therefore mutually exclusive projects are inter-dependent projects on each other.  Under mutually exclusively projects concept of capital rationing come into play. Capital budgeting rationing is the situation under which company is available with more than one project or investments but having limited funds to support or undertaken project (Bankman, 2006). In this case ranking concept shall be applicable and project having first rank will be accepted. Ranking shall be on the basis of profitability index. Along with raking concept projects having lower IRR shall be selected because it is the rate at which present value of cash inflow is equal to present value of cash outflow. In this case following is the rank of project according to profitability index:

Projects

PI

Rank

IRR

Project SQ

1.13

II

16.87%

Project HT

1.15

I

15.24%

Since both method of capital appraisal suggest that project HT shall be selected because it has been ranked I and it has lower internal rate of return. On the basis of above points and table, between two mutually exclusively projects, project HT shall be selected.  

Bibliography

  • Arnold, G. (2005). Financial Management. Harlow: Steve Education Limited.
  • Badie, B. (2000). Capital Budgeting in Investment Decisions. London: Prentise Hall.
  • Bankman, J. (2006). Financial Planning. Washington: The Institution Brookings.
  • Hammond. (1999). A Practical Guide to Making Better Decisions. London: Harvard Business School Press, 1999.