Description
The purpose of this assignment is to allow the student to calculate the project cash flow using net present value (NPV), internal rate of return (IRR), and the payback methods.
Assignment Steps
Create a 350-word memo to management including the following:
- Describe the use of internal rate of return (IRR), net present value (NPV), and the payback method in evaluating project cash flows.
- Describe the break-even point and its importance.
- Describe the advantages and disadvantages of each method.
Calculate the following time value of money problems:
- If you want to accumulate $500,000 in 20 years, how much do you need to deposit today that pays an interest rate of 15%?
- What is the future value if you plan to invest $200,000 for 5 years and the interest rate is 5%?
- What is the interest rate for an initial investment of $100,000 to grow to $300,000 in 10 years?
- If your company purchases an annuity that will pay $50,000/year for 10 years at a 11% discount rate, what is the value of the annuity on the purchase date if the first annuity payment is made on the date of purchase?
- What is the rate of return required to accumulate $400,000 if you invest $10,000 per year for 20 years. Assume all payments are made at the end of the period.
Calculate the project cash flow generated for Project A and Project B using the NPV method.
- Which project would you select, and why?
- Which project would you select under the payback method? The discount rate is 10% for both projects.
- Use Microsoft® Excel® to prepare your answer.
- Note that a similar problem is in the textbook in Section 5.1.
Sample Template for Project A and Project B:
“Table showing investments and returns for Project A and Project B. Project A has $10,000 initial investment with $5,000 returns in each of the first 3 years. Project B has $55,000 initial investment with $20,000 in each of the first 3 years.”
Show all work.
Explanation & Answer
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Running head: MEMO
Memo to Management
Student’s Name
Professor’s Name
Course Title
Date
MEMO
2
Memo to Management
To:
From:
Date:
Subject:
Net Present Value is used to evaluate the profitability of a project. A positive NPV gives the
impression that the expected revenue from the project is higher than the expected cost
associated with the project.
On the other hand, a negative NPV implies that the expected cost of the project exceeds the
revenue generated from the investment. The NPV rule states that a project with a positive NPV
should be accepted while a negative NPV should be rejected. The advantages of using NPV in
evaluating a project's cash flow is that it takes into account the Time Value of Money. It states
that a dollar today is worth more than a dollar tomorrow. However, a challenge with NPV is
the difficulty in estimating the cost of capital of a firm. If the cost of capital is estimated to be
high, it will scare away investors (Adusumilli et al., 2016). On the other hand, if the cost of
capital is too low, it will result in sub-optimal investments.
The Internal Rate of Return (IRR) uses the same formula to calculate the NP. However, the
IRR uses a discounted rate that equates the NPV from all cash flow to zero. Also, unlike NPV,
the rate of IRR is constant in every year of life of the investment. The method assumes that the
cost of investment is equal in all the projects. The advantage of this method is that it is simple
to calculate and takes into account the time value of money. However, it ignores the economies
of scale and has an unrealistic assumption of reinvestment rate of return (Patrick et al., 2016).
MEMO
3
Payback Period is the time taken for an investment pay back the capital invested. The shorter
the payback period, the better the investment and vice versa. It is expressed in years and a
fraction of years. It is simple to calculate as it involves dividing initial investment with the by
the amount of cash inflow from the project annually. Its simple nature enhances quick decision
making by the managers (Gorshkov et al., 2018). However, the setback with this method is that
it ignores profitability, it does not cover all cash flow, and it is unrealistic.
Break-even point is the point where the amount of revenue equals t...
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