Question

Describe the following project breakeven and profitability measures.

Be sure to include each measure's economic interpretation and why it is important for non financial managers to understand.

*   Payback

*   Net Present Value (NPV)

*   Internal Rate of Return (IRR)

Answer 1

Payback: It is a period where the venture under thought will restore the speculation made by the financial specialist.

Eg: Total investment = $130,000

Yearly cash flow from the firm = $30,000

Then the Payback period = Total investment / Yearly cash flow

= $200,/00/$25,000

= 8

Net present value (NPV): Net present esteem (NPV) is the distinction between the present estimation of money inflows and the present estimation of money surges over some stretch of time. It is used in capital and investment planning to investigate the productivity of an anticipated speculation or undertaking.

Eg: Cash inflow = $130,000

Cash outflow = $100,000

NPV is positive, then the project is accepted.

Internal rate of return (IRR): The internal rate of return is a proportion of a venture's rate of return. The term excludes all the external terms such as risk free rate, inflation, cost of capital or different budgetary risks.

Eg: If the project has the 15% IRR and If the firm requires minimum 20%, then the project will be rejected.