Question

Question 3: Accounting & Finance

Capital investment decisions look at how businesses should assess proposed investments in new plant, machinery, buildings and other long-term assets. The essential feature of investment decisions is time. There are different approaches/methods used by businesses to evaluate investment opportunities such as accounting rate of return, payback period, net present value, and internal rate of return.

Suppose that you are an analyst for a company considering investments in three projects with the same class of risk listed in Table 1. Your manager has asked you to rank the projects and recommend the best two projects that the company should accept. Note that the company’s cost of capital is 10%.

Table 1: projects’ free cash flow

Year	Project   1	Project 2	Project 3
0 (initial investment)	$ (10,000)	$ (10,000)	$ (10,000)
1	16,000	4,000	6,000
2		6,000	2,000
3		2,000	8,000
4		4,000	0

Questions:

1. Can you rank the projects by simply comparing the cash inflows and outflows for the projects? Explain why?
2. Use the quantitative methods (payback and NPV) you have learned in this module to evaluate the projects.
3. Calculate IRR for project 2 and project 3. Interpret your results
4. Based on your results, recommend the best two projects that the company should accept. (2 mark)
5. Which quantitative ranking method is better? Why?
6. Suppose that projects 1 and 3 are mutually exclusive, does your decision differ from the ranking obtained from step 3 above.

                       

Answer 1

4) So, the two best project that should be selected is project 1 and project 3 because they have higher NPV.

5) The quantitative method that is better is the NPV method because it considers all the cash flows and also the time value of money.

6)if projects 1 and project 3 are mutually exclusive then it will affect the choices because they are the two bets project so in that case project 1 and project 2 would have to be selected and project 1 would be first in ranking and project 2 would be second in ranking.