# Discussion board postings

1.

After reading chapter 10, I chose Net Present Value to evaluate. “The decision rule is: If the present value of incremental net cash inflows is greater than the incremental investment net cash outflow, approve the project.” (Schneider, 2012, sect. 10.3). With this method, each year of cash flows is reduced by the interest rate – this rate is usually the cost to finance the project (Schneider, 2012). These numbers are considered the present value of each year and are added to the current year’s flows (Schnieder, 2012). If there is a positive net balance, the project should be kept, if it is negative, that shows an overall loss on the project and it can be removed from investments (Schneider, 2012). “Despite the difficulties associated with selection of an appropriate rate of return and its limited validity in modeling real project risks, the NPV method has been widely embraced by corporations, municipal entities, and investors in general because of its simplicity” (Espinoza & Morris, 2013), p. 474. I think this quote speaks to both the drawback and benefit of using NPV. As long as a correct rate of return (interest rate) can be selected, it can be fairly accurate, even without taking ‘real world’ risks into account. I would use this method because it includes the entire life of the project’s cash flows and also incorporates the cost of investment. I feel that all the inflows and outflows are accounted for and can show a behavioral trend of the project over time. For example, while evaluating, if the present value inflows are showing a trend of decreasing every year, it can give the company a clue to make the investment in this project a lower priority to something that could present a higher trend of inflows. Espinoza, D., & Morris, J. W. (2013). Decoupled NPV: a simple, improved method to value infrastructure investments. Schnieder, A. (2012).
2. The net present value (NPV) method includes the time value of money by using an interest rate that represents the desired rate of return or, at least, sets a minimum acceptable rate of return. The decision rule is: If the present value of incremental net cash inflow is greater than the incremental investment net cash outflow, approve the project (Schneider, 2012). The advantage of net present value method is that it considers the time value of money. The disadvantage is that it is more difficult than other methods that do not consider present value of cash flows (AccountingFormanagement.org). I chose the net present value method because more business would directly benefit from it. The net present value method effects the everyday decisions that management are faced with. Examples of some decisions would be whether or not to purchase new equipment or expand the company. These are major decisions that management does not take lightly. The net present value will aid in the decision making process. Investments that are made by an organization affect all of the individuals associated with the company in any way. One method that works for one company may not necessarily work the same as another. The net present value method would be the most used do to how it operates. References: Journal of Accounting, Auditing & Finance. Jan2012, Vol. 27 Issue 1, p123-144. 22p. 6 Charts. Journal of Financial & Quantitative Analysis. Oct2012, Vol. 47 Issue 5, p933-972. 40p. Schneider, A. (2012)
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1. The acceptable projects based on profitability index are: J, F, A, and H, with a $300,000 balance earning the cost of the capital rate (14%). 2. The acceptable projects based on NPV are: E, J, F, and A – this uses all available funds. 3a. The only change in acceptable projects from question two is the removal of project A from the list of investments. It also narrows the balance earning the cost of capital rate for question one to $100,000. 3b. To find the opportunity cost for the $200,000 that was eliminated from the investments when the available amount dropped to $1,000,000, I went to investopedia.com (2015) for additional information on opportunity costs – essentially the difference between choices made. In this case, eliminating the $200,000 would cost the NPV of $22,000 dollars. There is no alternative income, so there is nothing to offset the amount with an alternative income. Opportunity Cost. (2015). Investopedia.com. Retrieved from: http://www.investopedia.com/terms/o/opportunitycost.asp Schneider. (2012)
4.
1. Take on J, F, A, and H with room to take on project B as there would be a 300,000 balance left 2. The acceptable projects for NPV are E, J,F, and A which will use all available funds. 3. A. Project A would have to be cut as the other three projects would take up the designated capital. B. It is essentially the cost of making a different choice. In this case it would be the 22000 dollars NPV that is lost due to a decrease in available investment funds. Schneider. (2012) |