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The Investment Detectivev
1. Can you rank the projects simply by inspecting the cash flows?
By evaluating the cash flows the projects cannot be ranked. This is due to the fact
that it is the time value of money and cost of capital which governs the cash flow
of the project. Time value of money is the future value on the present value of the
company. The future value will be received with a certain rate of interest which is
called the discounting rate ((Zaman and Movassaghi, 2002).
The cash flows cannot help in estimating the company’s profitability. This is also
known as the return on investment. Suppose the weighted average cost of capital
(WACC) is 10%, then the return must be greater than 10%. Hence, it is positive
cash flows which means excess of cash flow over the initial investment made by
the company. Also, there are various qualitative factors which are considered in the
cash flow evaluation process. Due to these reasons the projects with a negative
cashflows are accepted. Since, the cash flows are estimated for these projects the
manner in which these are done is an important factor which needs to be adhered.
2. What criteria might you use to rank the projects? Which quantitative ranking
methods are better? Why?
For ranking the projects, we can use several methods based on the capital budgeting
decisions. These methods are generally the Net present value, Internal rate of return
and modified internal rate of return. These methods are used to find the project’s
viability. Also, it’s the profitability index which can be used for measuring the
profitability of the business. Most of these models are called the discounted cash
flow methods which emphasizes on the cash inflows and outflows by considering
the time value of money (Bhimani et al., 2015). By calculating the cash flows using
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these methods we can estimate whether the sum of cash flows exceeds the expected
return or the cost of capital of the project. This information can further be used for
estimating the payback period. Finally, NPV is the best method to know the
company’s earning probability by discounting back the present value.
3. What is the ranking you found by using quantitative methods? Does this ranking
differ from the ranking obtained by simple inspection of the cash flows?
Project
Number
1
2
3
4
5
6
7
8
WACC
10%
Ranking as per
excess of cash
flow over
initial
investment
5
8
1
4
2
7
6
3
NPV
$73.09
-$85.45
$393.92
$228.22
$129.70
$0.00
$165.04
$182.98
Ranking as per
NPV
6
8
1
2
5
7
4
3
IRR
10.87%
6.31%
11.33%
12.33%
11.12%
10%
15.26%
11.41%
Ranking as per
IRR
6
8
4
2
5
7
1
3
MIRR
10.49%
8.41%
11.33%
10.65%
10.46%
10%
11.76%
11.18%
Ranking as per
MIRR
5
8
2
4
6
7
1
3
Profitability
Index
1.04
0.96
1.2
1.11
1.06
1
1.08
1.09
Ranking as per
Profitability
Index
6
8
1
2
5
7
4
3
Payback
Period
7
2
15
6
8
1
2
7
Ranking as per
Payback period
5
2
8
4
7
1
3
6
Due to usage of rankings as per the quantitative methods and the excess of cash flow
over investment there is considerable differences in the rankings. The cells which are being
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highlighted in yellow are the top 4 rankings. From an investor’s perspective, one must use a
combination of the above criteria for selecting the project. As per the above chart it is project
3, 4, 7 and 8 which can be considered viable options as on an average these projects are ranked
higher than the other projects.
4. What kinds of real investment projects have cash flows similar to those in
Exhibit 1?
Project 1 can be considered as a coupon bond which has a high par value and the
payments are made periodically at the end for getting the principal amount.
Project 2 can be considered for purchasing an equipment as well as for venture
capital project
Project 3 is similar to a 15-year Certificate of Deposit (CD) which delivers a high
rate of return.
Project 4 is considered as company which goes in specific areas, makes certain
alterations, considers profitability and are able to generate huge profits for the
business.
Project 5 is equivalent to an annuity which provides money for the duration of
investment.
Project 6 is almost equivalent to a Treasury bill
Project 7 is an organization which purchases hardware. The yields reduces and the
trade streams turning out as the gears are implemented strongly.
Project 8 is almost similar to an organization dealing in aviation sector which burns
through start to cash. This is especially due to increase in the research and
developmental costs. During this time the profits are incurred for the life terms as
the benefit of this increment is quite huge.
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References
Zaman, M.R. and Movassaghi, H. (2002). “Interest-Free Islamic Banking: Ideals and Reality.
The International Journal of Finance, Vol. 14, No. 4, pp. 24282443.
Bhimani, Hongren, Datar, & Rajan. (2015). Cost and Management Accounting (6th ed.).
Pearson publishers

Unformatted Attachment Preview

The Investment Detectivev 1. Can you rank the projects simply by inspecting the cash flows? By evaluating the cash flows the projects cannot be ranked. This is due to the fact that it is the time value of money and cost of capital which governs the cash flow of the project. Time value of money is the future value on the present value of the company. The future value will be received with a certain rate of interest which is called the discounting rate ((Zaman and Movassaghi, 2002). The cash flows cannot help in estimating the company’s profitability. This is also known as the return on investment. Suppose the weighted average cost of capital (WACC) is 10%, then the return must be greater than 10%. Hence, it is positive cash flows which means excess of cash flow over the initial investment made by the company. Also, there are various qualitative factors which are considered in the cash flow evaluation process. Due to these reasons the projects with a negative cashflows are accepted. Since, the cash flows are estimated for these projects the manner in which these are done is an important factor which needs to be adhered. 2. What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why? For ranking the projects, we can use several methods based on the capital budgeting decisions. These methods are generally the Net present value, Internal rate of return and modified internal rate of return. These methods are used to find the project’s viability. Also, it’s the profitability index which can be used for measuring the profitability of the business. Most of these models are called the discounted cash flow methods which emphasizes on the cash inflows and outflows by considering the time value of money (Bhimani et al., 2015). By calculating the cash flows using these methods we can estimate whether the sum of cash flows exceeds the expected return or the cost of capital of the project. This information can further be used for estimating the payback period. Finally, NPV is the best method to know the company’s earning probability by discounting back the present value. 3. What is the ranking you found by using quantitative methods? Does this ranking differ from the ranking obtained by simple inspection of the cash flows? Project Number WACC Ranking as per excess of cash flow over initial investment NPV Ranking as per NPV IRR Ranking as per IRR MIRR Ranking as per MIRR Profitability Index Ranking as per Profitability Index Payback Period Ranking as per Payback period 1 2 3 4 5 6 7 8 5 8 1 4 2 7 6 3 $73.09 -$85.45 $393.92 $228.22 $129.70 $0.00 $165.04 $182.98 6 8 1 2 5 7 4 3 10.87% 6.31% 11.33% 12.33% 11.12% 10% 15.26% 11.41% 6 8 4 2 5 7 1 3 10.49% 8.41% 11.33% 10.65% 10.46% 10% 11.76% 11.18% 5 8 2 4 6 7 1 3 1.04 0.96 1.2 1.11 1.06 1 1.08 1.09 6 8 1 2 5 7 4 3 7 2 15 6 8 1 2 7 5 2 8 4 7 1 3 6 10% Due to usage of rankings as per the quantitative methods and the excess of cash flow over investment there is considerable differences in the rankings. The cells which are being highlighted in yellow are the top 4 rankings. From an investor’s perspective, one must use a combination of the above criteria for selecting the project. As per the above chart it is project 3, 4, 7 and 8 which can be considered viable options as on an average these projects are ranked higher than the other projects. 4. What kinds of real investment projects have cash flows similar to those in Exhibit 1? Project 1 can be considered as a coupon bond which has a high par value and the payments are made periodically at the end for getting the principal amount. Project 2 can be considered for purchasing an equipment as well as for venture capital project Project 3 is similar to a 15-year Certificate of Deposit (CD) which delivers a high rate of return. Project 4 is considered as company which goes in specific areas, makes certain alterations, considers profitability and are able to generate huge profits for the business. Project 5 is equivalent to an annuity which provides money for the duration of investment. Project 6 is almost equivalent to a Treasury bill Project 7 is an organization which purchases hardware. The yields reduces and the trade streams turning out as the gears are implemented strongly. Project 8 is almost similar to an organization dealing in aviation sector which burns through start to cash. This is especially due to increase in the research and developmental costs. During this time the profits are incurred for the life terms as the benefit of this increment is quite huge. References Zaman, M.R. and Movassaghi, H. (2002). “Interest-Free Islamic Banking: Ideals and Reality. The International Journal of Finance, Vol. 14, No. 4, pp. 2428–2443. Bhimani, Hongren, Datar, & Rajan. (2015). Cost and Management Accounting (6th ed.). Pearson publishers Name: Description: ...
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