Managers can choose from several analytical techniques to help them make capital investment decisions. Each technique has advantages and disadvantages. Respond to the following in a minimum of 175 words: Provide an example or brief business case in which you can apply the NPV, IRR or payback concepts to make the most adequate financial decision. Select one of the techniques - NPV, IRR, or payback and explain why you would choose this technique as well as any disadvantages when compared to the others.
Managers can choose from several analytical techniques to help them make capital investment decisions. Each technique has advantages and disadvantages.
Respond to the following in a minimum of 175 words:
- Provide an example or brief business case in which you can apply the NPV, IRR or payback concepts to make the most adequate financial decision.
- Select one of the techniques - NPV, IRR, or payback and explain why you would choose this technique as well as any disadvantages when compared to the others.
ANSWER:-
1.
Net Present Value (NPV) is a widely used technique for capital investment decisions. It measures the present value of the expected cash flows generated by the investment minus the initial investment. A positive NPV indicates that the investment is expected to generate more cash flows than the initial investment and hence, is considered a good investment. A business case for NPV could be the investment in a new project to develop a new product. The NPV calculation could be done by estimating the expected cash flows from the sales of the new product and subtracting the costs of research and development, production, and marketing. If the NPV is positive, the company could consider proceeding with the investment as it is expected to generate a positive return.
Internal Rate of Return (IRR) is another commonly used technique for investment decisions. IRR measures the rate of return that the investment is expected to generate. An IRR greater than the cost of capital is considered a good investment, and the investment should be made if the NPV is positive. A business case for IRR could be the investment in a new factory. The IRR calculation could be done by estimating the expected cash flows from the factory operations, subtracting the costs of the factory, and determining the rate of return. If the IRR is greater than the cost of capital and the NPV is positive, the company could consider proceeding with the investment.
Payback is another technique used to evaluate investment decisions. Payback is the period required to recover the initial investment in the investment. A shorter payback period is considered a good investment. A business case for Payback could be the investment in a new marketing campaign. The payback calculation could be done by estimating the expected cash flows from the campaign, subtracting the costs of the campaign, and determining the payback period. If the payback period is short, the company could consider proceeding with the investment as it is expected to recover the initial investment quickly.
In conclusion, different analytical techniques could be used to make capital investment decisions, and each has its advantages and disadvantages. The NPV, IRR, and Payback techniques are commonly used and provide valuable information to help managers make informed investment decisions.
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
