Question

1) Explain the Cash Payback Technique.

2) Explain the two methods for determining the Discounted Cash Flow technique

3) Explain the profitability Index for mutually exclusive projects and what does a positive NPV indicate? A negative NPV?

4) What is meant by [performing a post-audit of investment projects?

5) Explain what the Internal Rate of Return Method (IRR) does?

6) What is the decision rule for NPV> For IRR

7) What is the Annual Rate of Return?

Answer 1

1. Cash Payback Period : It is a period of expected time to receive invested amount. Less investment period is benefial for the investor.

Calculation of Cash Payback Period : Initial Investment/ Net cash flow

Example : Initial Investment $ 50,000 & cash flow for every year $5,000 Cash Payback Period ?

        Cash Payback Period = $ 50,000/$5,000 = 10 Years

2. To determine Discounted Cash Flow Technique are two methods

NPV : It is difference between Cash inflows - Initial Cash Outflows. If it is positive can accept project otherwise reject the project.

Example : Initial outflows = $ 5,000 Every year cash inflow $ 2,000 for 5 years @10%/discount factor

                                             NPV = Cash inflow - Cash outflow

                                                       = $2,000*3.7907(10%,5years) - $ 5,000

                                                        =$7,582 - $5,000

                                                        =$2,581

IRR : Internal Rate of Return = It is a discount rate where all NPV'S are zero. Where, NPV is,

          Cash inflows = Cash outflows

Example : Initial Outflow is $ 300,000 & Cash inflows 150,000 for 3 years & salvage value $ 10,000 for 3rd year , Where IRR 24.31 % where Npv is 0 .

=$300,000/$ (140,000) = 2.14 years (refer table to see IRR discount rate)

3. Profitability Index : = Cash inflow/ cash outflow . It's shows the profitability of the project & take decision whether to accept that project or not . This is alternative method. when NPV is negative that that you can take decision on the basis of Profiability Index.

Positive NPV Means can accept Project & Negative NPV means don't accept that project . If there is Negative NPV can use Profitability Index to take decision whether to accept project or not.

4. Performing a post-audit of investment projects : After the Project has approved Post audit of investment has conducted to verify whether expected result are actually realised or not. Project approved on the basis of NPV. Through this understant whether project is in proper conducting or not.

5. Internal Rate of Return Method : It is discount rate which ,

• Estimate the profitability of potential investment. It determines how well a project or investment performa over a period. It also take into account time value of money.

6. NPV > IRR = Both co related each other . NPV take decision accept or reject of the project, to decide that discount rate is required that is IRR.

Decision Rule

• If more NPV & Less IRR = Means acceptability of Project is higher, because higher NPV
• If less NPV & more IRR = Means acceptability of project is lower, because lower NPV

                           In given situation NPVis more than IRR so Project can accept because of higher NPV & lower IRR

7. Annual Rate of Return : Means Interest /Retuen received over a period of time on investment.

    = Ending value / (Beginning value)n years - 1