is the subject of Chapter 13. The knowledge is necessary to understand and motivate the capital budgeting models. It relates NPV - IRR procedures to the required rate of return idea‚ something with which students are already familiar. We explicitly tie NPV and IRR together by emphasizing that the IRR comes from the NPV equation as the interest rate that sets NPV=0. This helps to develop an overall understanding of both procedures. TEACHING OBJECTIVES After this chapter students
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A) Why is the investment appraisal process so important? Capital Investment Appraisal is of fundamental importance because: 1. Large Amount of Company Resources: Involvement of large amount of company resources and efforts which will necessitate careful evaluation to be undertaken before a decision is reached. 2. Maximization of Shareholder wealth: Investment decision is linked with strategic and tactical business decisions and therefore need to achieve desired long-term objectives. The
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in Mexico. They will need to use pesos to calculate their cash flows to see how this part of their project will impact their finances. They also need to convert this peso amount into Euros. We began the analysis by computing the Net Present Value (NPV) of Ariel-Mexico’s recycling equipment. This was done by first taking the incremental peso cash flow rate by subtracting the cost of the old manual equipment‚ from the cost of the new equipment. As is displayed in [exhibit XX] the incremental cash
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Tri Star Lockheed 1. (A) The payback is 35‚000/5‚000= 7 years Computation of the NPV : 15 NPV= -35‚000 + Σ 5‚000 / ( 1 + 12%)^ 15 i=1 NPV = $- 947. 67 Computation of the IRR : 15 0= -35‚000 + Σ 5‚000 / ( 1 + IRR)^ 15 i=1 IRR= 11.49% The NPV of this project is negative and the IRR is lower then the Cost of Capital (12%) Rainbow products
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to Concepts Review and Critical Thinking Questions 1. Assuming conventional cash flows‚ a payback period less than the project’s life means that the NPV is positive for a zero discount rate‚ but nothing more definitive can be said. For discount rates greater than zero‚ the payback period will still be less than the project’s life‚ but the NPV may be positive‚ zero‚ or negative‚ depending on whether the discount rate is less than‚ equal to‚ or greater than the IRR. The discounted payback includes
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Metalcrafters can only choose 1 to order. Additionally‚ management had to choose between 2 parts orders between Eades Electric and Sawmasters due to limited capacity. Analysis of the future cash flows from each press is located in the appendix. The NPV method was the preferred evaluation method for reasons mentioned in the following section. The further analysis will show why the MD-40 prevails against the SX-65 as well as why the larger extrusion press is favorable to the smaller one. In addition
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of mutually exclusive investments. 5) Synthetic Resin NPV: NPV = CI – CO NPV = [(350‚000)/(1 + 0.1)^1 + (400‚000)/(1+0.1)^2 + (500‚000)/(1 + 0.1)^3 + (650‚000)/(1 + 0.1)^4 + (700‚000)/(1 + 0.1)^5] – 1‚000‚000 NPV = 1‚903‚024 – 1‚000‚000 NPV = 903‚024 Epoxy Resin NPV: NPV = [(600‚000)/(1 + 0.1)^1 + (400‚000)/(1+0.1)^2 + (300‚000)/(1 + 0.1)^3 + (200‚000)/(1 + 0.1)^4 + (200‚000)/(1 + 0.1)^5] – 1‚000‚000 NPV = 1‚362‚212 – 800‚000 NPV = 562‚212 The
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and comparison of project appraisal techniques. The Net Present Value (NPV) method is used by 75% of firms when deciding on investment projects. The reasons for its wide use is that firstly‚ the NPV rule takes into account the time value of money‚ meaning that it recognises that a pound today is worth more than a pound tomorrow as the pound today can be invested to start earning interest immediately. Secondly‚ NPV depends solely on the forecasted cash flows from the project and the opportunity
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the NPV approach to investment appraisal and compare the strengths and weaknesses of the NPV approach to two other commonly used approaches. (30 marks) This first section of this paper will provide a brief explanation on theoretical rationale for the net present value (NPV) method of investment appraisal and then compare its strengths and weaknesses to two alternative methods of investment appraisal‚ those of internal rate of return (IRR) and pay-back. Theoretical rationale for the NPV approach
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macroeconomic factors like exchange rate‚ inflation and interest rate has made the valuation of the project very complex. Compute the NPV of Ariel-Mexico’s recycling equipment by counting incremental peso cash flows at a peso interest rate. How should this NPV be translated into Euros? Assume expected future inflation for France is 3% per year. For the purpose of calculating NPV in Pesos‚ incremental cash flows of the project for the next 10 years should be calculated first. The initial outflow of cash flow
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