Project Evaluation
Project Evaluation

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. Longterm 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.

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.

Payback period_{A} = 3 years + = 3.4years
Payback Period_{B} = 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.

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.

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 
NPV_{A} = – IO = 110,000 – (17860+23910+28480+31800+39690) = $31,740
NPV_{B} = – 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

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
PI_{A} = = = 1.2885
PI_{B} = = 1.3109
Projects A & 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% 
IRR_{A} = 20.97%
IRR_{B} = 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 cashinflows over the project’s life arereinvested at the predetermined 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 4^{th}Edition. Britain: Pearson Education.