INDIVIDUAL ASSIGNMENT – 8
Prof Shradha Wilfred.
Mohammed Yousuf –A00182827
1. What is the difference between capital budgeting screening decisions and capital
budgeting preference decisions?
A) Capital budgeting screening decisions: If a proposed project satisfies a current
standard of acceptance then it is called as screening decisions.
For instance a business might have a policy of accepting projects only if they
promise a return say , 20% on the investment. The required rate of return is the
minimum rate of return a project must yield to be acceptable.
Capital budgeting preference decisions: Preference decisions are the ones where
you choose between multiple courses that are in competition.
For instance a business might look after several machines in order to replace a
machine.
2. What is meant by the term time value of money?
A) The idea that an amount of money has more value now than it would have later
because of its potential for revenues in the gap is called as time value of money.
For instance A dollar today is worth more than a dollar a year from now. The main
idea here is to investigate dollar today to generate positive revenue.
3) What is meant by the term discounting?
A) The process of changing a value that is received later on to a value that is
received right away is called as discounting.
Discounting measures the relative value of money, which indicates that a dollar
acquired fifty years from now would be worth less than a dollar received today.
4) Why is the NPV method of making capital budgeting decisions superior to other
methods, such as the payback and SRR methods?
A) The difference between the cash inflows and outflows of an investment project
as of their respective present values is called as net present value.
The NPV method of making capital budgeting decisions is superior to other
methods because NPV is capable of handling several cash flow directions or
multiple discount rates.
The NPV approach is more adaptable for analyzing specific periods since each
year's cash flow can be discounted independently of the others.
5) What is NPV? Can it ever be negative? Explain.
A) The difference between the cash inflows and outflows of an investment project
as of their respective present values is called as net present value. For instance if a
project or purchase would increase the worth of your firm, you can use the net
present value (NPV) calculation.
A positive net present value (NPV) indicates that the total discounted cash inflows
exceed the whole discounted cash outflows. If the project's return is high and no
capacity restrictions come up, the business will profit financially more from it.
When a project's net present value (NPV) is negative, it means that the business
has spent more money than it expected during the project's duration. For financial
reasons, a project should not be approved if its net present value (NPV) is negative
since it is unprofitable.
6) "If a firm has to pay interest of 14% on long-term debt, then its cost of capital is
14%." Do you agree? Explain your answer.
A) No I do not agree with the given statement because cost of capital is defined as
the calculated average of the costs associated with different funding sources,
including debt and equity, is known as the cost of capital.
The interest rate on long-term debt is just one component of the cost of debt. Here
on calculating interest rate equity is not involved. Because of not intervening
equity in interest rate I say that the given statement is false.
7) What is meant by "an investment project's internal rate of return"? How is the
internal rate of return computed?
A) The internal rate of return (IRR) is a measure of the projected return on
investment that a project offers during its period of use. It is the discount rate at
which the project's net present value is zero.
If the internal rate of is equal or greater than cost of capital, then the project
should be accepted if not no.
1
IRR is calculated using the relation 1+ IRR =PV factor
For instance The initial investment of a firm is $1,42,514. The total cash inflow
after one year is $1,49,700.
So according to the problem, 1,42,514 = pv factor * 1,49,700
Pv factor = 1,42,514/1,49,700
PV factor = 0.952
1
=0.95 2
1+ IRR
IRR = (1-0.952)/0.952 = 5.04%.
8. Explain how the cost of capital serves as a screening tool when dealing with the
NPV method.
A) In case of net present value method the cost of capital serves as discount rate
which will be helping to calculate NPV.
9. "As the discount rate increases, the present value of a given future cash flow
also increases." Do you agree? Explain your answer.
A) No I do not agree with the given statement because Future cash flows are
reduced by the discount rate; so, the higher the rate, the less the future cash flows'
present value will be. A larger present value is the result of a lower discount rate.
This suggests that money in the future will be worth less than it is today, i.e., it will
have less purchasing power, when the discount rate is higher.
10. Refer to L Exhibit 10-3. Is the return on this investment proposal exactly 20%,
slightly more than 20%, or slightly less than 20%? Explain your answer.
A) Given initial cost is $5,000, period of time is 5 years and annual cost of savings
is $1800 then rate of interest is greater than 20% because,
ROI = 1800*5 – 5000/5000
=0.80*100
= 80%
Here since rate of interest is more and npv is positive then the company will accept
it.
