Assume that you’re a high-level executive that must make a decision as to whether or not...

Assume that you’re a high-level executive that must make a decision as to whether or not you should invest in a project that will yield positive cash flows. Assume that the investment to be made is $250,000

What methods would you employ to assist in you evaluating and making your decision.

Expert Solution

The two methods that can be used is

a) NPV

b) IRR

a) NPV method is used to see whether the discounted value of future positive cashflows are more than the initial investment. Say you decided that the Cost of Capital will be 10%, so you will discount all cash inflows with 10% and see whether the sum total of all cash inflows standing in present is more than the initial cash outflow that the company will have to incur. If the difference between Present Value of future cash inflows and Initial Cash Outflow is positive, then the NPV of the project is positive and you should accept the project. So the inflows will be more as compared to the outflows.

NPV = PV of Cash Inflows - Cash Outflow

b) IRR (Internal Rate Of Return) helps us to find a rate that makes the Present Value of Future Inflows equal to the Initial Outflow. So if that rate is more than cost of capital then the project can be accepted. It is because, your project will yield more return than you need to pay for the arrangement of the capital.

Outflow = Inflow / ( 1 + IRR)

jeff jeffy answered 2 years ago

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