tem.
B) Which project should the company choose based on NPV and why?
The net present value is stated as the amount of present values of the individual cash flows of the same entity.(Khan, M.Y., 1993) Moreover, NPV also can be described as the differentiation of discounted sum which mainly pointed out cash inflows and cash outflows. (Grubbström, Robert W., 1967)
The formulation of net present value is , so
Project A:
NPV1 = -$54000+ $12,700/(1+14%)1+ $23,200/(1+14%)2+ $27,600/(1+14%)3+ $4,6500/(1+14%)4
= -$54000+ $11,140.35+ $17,851.65+ $18,629.21+ $27,531.73
= $21,152.94
Project B:
NPV2 = -$23,000+ $11,600/(1+14%)1+ $11,200/(1+14%)2+ $12,500/(1+14%)3+ $6,000/(1+14%)4
= -$23,000+$10,175.44+ $8,618.04+ $8,437.14+ $3,552.48
= $7,783.1
The calculation process compares the net present value of the difference between project A and B , as well fluctuating inflation and payback.
Both net present value for A and B are positive that certificate that the two types investment of realistic return rate is higher than the required return rate. The investment rate of return for project A is better than the project B thus it can be selected.
C) Which project should the company choose based on IRR and why?
IRR is internal rate of return is a rate of return applied in capital budgeting to evaluate and confront the profitability of investments. (Hartman, J. C.& Schafrick, I. C., 2004) As for how to run out the internal rate of return, it has closely relationship with net present value, explained by a word a rate of return for which this function is zero is an internal rate of return.
So the function can be described , the internal rate of return is a rate quantity, hence for project A and B, it is also a emblem of efficiency, effectiveness, or yield of an investment when measure a project. Comparing with the net present value that is an presenter of the magnitude of an investment.
Project A:
IRRa= -$54000+ $12,700/(1+ra)1+ $23,200/(1+ra)2+ $27,600/(1+ra)3+ $4,6500/(1+ra)4 =0
Using excel: ra≈28.50%
Project B:
IRRb=-$23,000+$11,600/(1+rb)1+ $11,200/(1+rb)2+ $12,500/(1+rb)3+ $6,000/(1+rb)4 =0
Using excel: rb ≈30.94%
Both project A and B can be acceptable for the firm because the calculated internal rate of return is higher than their minimum acceptable rate of initial investment. However, in contrast with the initial investment value between project A and B, A has twice initial capital expenditure than B whereas its internal rate of return is higher than the A.
Hence, only
Referenced IRR as standards B should be selected due to it using less cost receive more payback. In general, a firm ought to coordinated IRR and NPV or other more complex factors that influence its investment rate of return.
D) Which project should the company choose based on profitability index and why?
Profitability index is the ratio of payoff to investment of a proposed project. It is a useful tool for ranking projects because it allows the to evaluate the sum of value created per unit of investment.(Audit IT, 2014)
The ratio is calculated as
Project A:
PVa=$12,700+ $23,200+ $27,600+ $4,6500/(1+14%)4≈ $65,129
PIa= $65,129/$54,000= 1.206
Project B:
PVb=
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