Question

discuss in a few sentences: the definition of relevant information, and an example of non-relevant information and why it is not helpful in the decision-making process
discuss in a few sentences: the Net Present Value method. Discuss the mechanics of how it's computed and the logic and purpose of the method itself.

Answer 1

Definition of relevant information-

In simple words, relevant information means the information or data which is necessary for making decision. Relevant information changes according to different decisions and which is not a historical or sunk cost. The concept of relevancy depends upon different alternatives available. What is relevant for one alternative may not be relevant for another alternative. Or, which can be avoided if the particular alternative is not accepted is a relevant information. Example -

Variable manufacturing costs are relevant costs, as they change according to number of units manufactured.

Example of non - relevant information -

Rent of building, salaries of personnel are fixed costs or non relevant cost as they will not change whether production activity is carried or not.

Non relevant information is not helpful in decision making process because it does not change with different alternatives. Even if non relevant information is not considered, it does not impact the decision making process, like sunk cost or historical cost which has already incurred.

NET PRESENT VALUE METHOD -

Net Present value method is used in evaluation of investment or project. NPV is a tool for investment planning, to evaluate whether the proposed investment is beneficial or not.

Computation of NPV -

Present Value of expected future cash flows

Less - cash outflow of investment

The NPV method takes into account the discount rate or present value of annuity factor to provide for inflation.

If NPV is positive, then investment is beneficial. If NPV is negative, the investment is not beneficial.

Logic and purpose of NPV method -

1. NPV method considers that rate of return, which is least expected by organization. The minimum rate of return is taken as discount rate for discounting future expected cash inflows. The purpose is that, at least such particular minimum return should be recieved.

2. Generally, NPV method is used for long term investments where a period of more than one year is involved. The future cash inflows are computed on the idea that the value of money received in future will be less than value of money if received today. It means, it takes into account, the inflation which results in the most appropriate result of investment.

3 NPV method considers the future costs and benifits for evaluating investment.