Business Finance

Sigchi4life
Category:
Business & Finance
Price: $30 USD

Question description

Compare the results of the three (3) methods by quality of information for decision making. Using what you have know about the three (3) methods, identify the best project by the criteria of long term increase in value. (You do not need to do further research.) Convey your understanding of the Time Value of Money principles used or not used in the three (3) methods. Review the video titled “NPV, IRR, MIRR for Mac and PC Excel” (located at https://www.youtube.com/watch?v=C7CryVgFbBc) to help you understand the foundational concepts: 

Scenario Information:
Assume that two gas stations are for sale with the following cash flows; CF1 is the Cash Flow in the first year, and CF2 is the Cash Flow in the second year. This is the time line and data used in calculating the Payback Period, Net Present Value, and Internal Rate of Return. The calculations are done for you. Your task is to select the best project and explain your decision. The methods are presented and the decision each indicates is given below.

InvestmentSales PriceCF1CF2
Gas Station A$50,000$0$100,000
Gas Station B$50,000$50,000$25,000


Three (3) Capital Budgeting Methods are presented:
  1. Payback Period: Gas Station A is paid back in 2 years; CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in one (1) year. According to the payback period, when given the choice between two mutually exclusive projects, the investment paid back in the shortest time is selected.
  2. Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%:
    NPVgas station A = $100,000/(1+.10)2 - $50,000 = $32,644
    NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2 - $50,000 = $16,115
  3. Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station A is 41.421%.; for Station B, 36.602.
Summary of the Three (3) Methods:
  • Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A.
  • Under the NPV criteria, however, the decision favors gas station A, as it has the higher net present value. NPV is a measure of the value of the investment.
  • The IRR method favors Gas Station A. as it has a higher return, exceeding the cost of funds (10%) by the highest return.

Tutor Answer

(Top Tutor) Daniel C.
(997)
School: UCLA
PREMIUM TUTOR
Studypool has helped 1,244,100 students
Ask your homework questions. Receive quality answers!

Type your question here (or upload an image)

1825 tutors are online

Brown University





1271 Tutors

California Institute of Technology




2131 Tutors

Carnegie Mellon University




982 Tutors

Columbia University





1256 Tutors

Dartmouth University





2113 Tutors

Emory University





2279 Tutors

Harvard University





599 Tutors

Massachusetts Institute of Technology



2319 Tutors

New York University





1645 Tutors

Notre Dam University





1911 Tutors

Oklahoma University





2122 Tutors

Pennsylvania State University





932 Tutors

Princeton University





1211 Tutors

Stanford University





983 Tutors

University of California





1282 Tutors

Oxford University





123 Tutors

Yale University





2325 Tutors