Question

Question 1: Patrick Johnson is a manager for Star Company. He tells you that his company always maximizes profitability by accepting the investment opportunity with the highest internal rate of return. Explain to Mr. Johnson how his company may improve profitability by sometimes selecting investment opportunities with lower internal rates of return.

Question 2: What typical cash inflow and outflow items are associated with capital investments? Explain.

Answer 1

1)

• The IRR is a metric used in capital budgeting to estimate the profitability of potential investments.The IRR is a dicount rate that makes the Net Present Value of all cash flows from a particular project equal to zero.
• The IRR rule is a guideline for deciding whether to proceed with a project or investment.The rule states that a project should be pursued if the IRR is greater than minimum required rate of return or IRR is lower than cost of capital.
• The higher the IRR on a project, and the greater the amount by which it exceeds the cost of capital, the higher the net cash flows to the company. Investors and firm use the IRR rule to evaluate projects in capital budgeting, but it may not always rigidly enforced.
• A company may choose a larger project with low IRR because it generates greater cash flows than a small project with a high IRR.
• A company may prefer a project with lower IRR because it has other intangible benefits, such as contributing to a bigger strategic plan or impeding competition.A company may also prefer larger project with a lower IRR to a much smaller project with a higher IRR because of the higher cash flows generated by the larger project.

2)

• The statement of cash flow shows how a company spend its money(cash outflow) and from where a company receives its money (cash inflows).
• There are three sections in cash flow statement : Cash flow from operating activities, Cash flow from financing activities and Cash flow from investing activities

Cash flow from operating activities

Any cash spent or generated from company's day-to-day activities comes under this head, it includes

• cash received from sale of goods and services.
• interestpayments
• payment to suppliers
• wages and salaries paid

Cash flow from financing activities

Cash spent or generated from financing activities, including

• Dividend payments
• Bond offerings
• stock repurchases

Cash flow from investing activities

It includes purchase of non current Assets-that will deliver value in future,Investing activity is an important aspect of growth and capital.Capital Expenditure also found in this section.Few examples of Cash flow from investing activities are

• purchase of fixed assets
• sale of fixed assets
• collection of loans and insurance proceeds.
• sale of investment securities.

These are typical cash inflow and outflow items are associated with capital investments.