Project Evaluation Student`s

Project Evaluation

Project Evaluation

  1. Capital budgeting process is an important tool in evaluating the investment decisions (Arnold, 2012). It helps to assess the viability of the current and future projects in the firm. Long-term investment decisions are much vital as they involve committing huge funds in form of capital and such decisions are irreversible. Therefore the capital budgeting process prior to the implementation phase is important to the firm. The process will also help in selecting the most profitable projects in the firm.

  2. It is always hard to find an exceptionally profitable project in the real life economy. This is because the business environment is ever changing from one day to the other. Competitive environment is the most hindering factor abstracting the availability of extremely profitable projects. Due to the lack of entry barriers competitors will apply hostile takeovers to imitate the firms with successful projects.

  3. Payback periodA = 3 years + = 3.4years

Payback PeriodB = 3 years + = 2.75years

Project B is more preferable since it has the shortest PBP whileProject A should be rejected since it does not meet the criteria ofthe required payback period of 3 years.

  1. Disadvantages of payback period

  • It ignores time value of money

  • It ignores cash flows after payback period

  • It cannot be applied in evaluating projects with different useful lives.

  1. Calculating NPV

Year

Cash in flow (A)

Cash inflow (B)

PVIF12%,5

PV (A)

Cummulative PV (A)

PV (B)

Cumm. PV (B)

0

-$110,000

-$110,000

1.000

-$110,000

-$110,000

-$110,000

-$110,000

1

20,000

40,000

0.893

17,860

-92,140

35,720

-74,280

2

30,000

40,000

0.797

23,910

-68,230

31,880

-42,400

3

40,000

40,000

0.712

28,480

-39,750

28,480

-13,920

4

50,000

40,000

0.636

31,800

-7,950

25,440

11,520

5

70,000

40,000

0.567

39,690

31,740

22,680

34,200

NPVA = – IO = 110,000 – (17860+23910+28480+31800+39690) = $31,740

NPVB = – IO = 110,000 – (35720+31880+28480+25440+22680) = $34,200

Therefore,both projects are acceptable since they have a positive NPV. However,Project B impore profitable than Project A with NPV of $34,200

  1. The logic behind NPV

NPV discounts all the costs and benefit of an investment anddetermine the difference (Arnold, 2012). If the NPV is negative itimplies that costs outweigh the benefit and therefore, the investmentis not viable.

g) Calculating the PI

PIA = = = 1.2885

PIB = = 1.3109

Projects A &amp B should be accepted since their PI is greater than1.

h) Yes, both NPV and PI should give the same accept or rejectdecision since they both use the same elements in evaluatingprojects.

i) If the discounting rate increases, NPV and PI reduces and if therate decreases, the NPV and PI increases.

j) Calculating IRR (with Microsoft excel functions)

Year

Cash inflow (A)

Cash inflow (B)

0

-110,000

-110000

1

20,000

40,000

2

30,000

40,000

3

40,000

40,000

4

50,000

40,000

5

70,000

40,000

IRR

20.97%

23.92%

IRRA = 20.97%

IRRB = 23.92%

k) The required rate of return has no effect on the internal rate ofreturn (IRR) but it affects the acceptance or rejection decision. Therequired rate of return provides the decision criteria to eitheraccept or reject a specific project. Adjustment on the required rateof return will therefore, have an impact on the decision to be made.

l) The NPV undertakes that cash-inflows over the project’s life arereinvested at the pre-determined rate of return. On the other hand,IRR assumes that cash inflows over the useful life of the project arereinvested over the remaining useful life of the project at theinternal rate of return (Arnold, 2012). NPV is the most acceptableand preferable project evaluation technique.

References

ArnoldG. (2011). Corporate Finance 4thEdition. Britain: Pearson Education.