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Words 628

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1. We can not rank the projects by only simple inspection of the cash flows because of the time value of money and cost of capital of companies. We use capital budgeting tools to measure financial performance of projects. The major available tools are IRR, MIRR and NPV. By using these tools we can conclude whether sum of the cash flows of a project exceeds expected return rate or cost of capital of a company or not.

Also there are qualitative factors that should be considered. A project can be critical for the company and even it has negative NPV, it could be accepted.

Also a company would prefer to have small experiments to identify possible profitable businesses before making a heavy investment to enter the market. In this case quantitative methods would not be enough to analyze the project.

Because most of the cash flows are estimated in most of the projects, quality of estimation is another factor to be considered besides numerical capital budgeting tool results.

2. I would use NPV since it is superior compared with IRR. I would also use profitability index. I would use also MIRR to enable easy communication among non-financial managers in the company by giving them a percentage score to evaluate projects. Finally I would calculate pay back information.

3. Project analysis

Project # 1 2 3 4 5 6 7 8

NPV 73.09 -85.45 393.92 707.01 129.70 0.00 165.04 182.98

PI 1.037 0.957 1.197 1.285 1.065 1.000 1.083 1.077

MIRR 10.49% 8.41% 11.33% 11.86% 10.46% 10.00% 11.76% 11.18%

Payback 6.06 2.00 14.20 6.05 7.14 0.90 1.88 6.08

Ranking with NPV

Project # 2 6 1 5 7 8 3 4

NPV -85.45 0.00 73.09 129.70 165.04 182.98 393.92 707.01

PI 0.957 1.000 1.037 1.065 1.083 1.077 1.197 1.285

MIRR ...

1) Without taking into account the time value of money, the projects ranked according to the cash flow are as follows:

3 , 5 , 8…...

...Case #17 The Investment Detective Synopsis and Objectives This case presents the cash flows of eight unidentified investments, all of equal initial investment size. The task is to rank the projects. The first objective of the case is to examine critically the principal capital-budgeting criteria. A second objective is to consider the problem that arises when net present value (NPV) and internal rate of return (IRR) disagree as to the ranking of two mutually exclusive projects. Finally, the case is a vehicle for introducing the problem created by attempting to rank projects of unequal life and the solution to that difficulty—the equivalent-annuity criterion. (Questions for this case are on page 257) THE INVESTMENT DETECTIVE Comparative Analysis of Investments 1. Project free cash flows (in thousands of dollars) Project number 1 2 3 4 5 6 7 8 Initial investment $(2,000) $(2,000) $(2,000) $(2,000) $(2,000) $(2,000) $(2,000) $(2,000) Year 1 $ 330 $1,666 $160 280 $2,2001 $1,200 $(350) 2 330 3341 200 280 9001 (60) 3 330 $ 165 350 280 300 60 4 330 395 280 90 350 5 330 432 280 $ 70 700 6 330 4401 280 1,200 7 3301 442 280 $2,2501 8 $1,000 444 2801 ...

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...The Investment Detective 1. Can you rank the projects simply by inspecting the cash flows? The company is able to perform initial ranking based on the cash flows overview, although it will not be sufficient to determine the true profitability. In this case the ranking of the projects is the following – 3, 5, 8, 4, 1, 7, 6 and 2. This ranking is supported by the excess of cash flows (CF). 2. What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why? Based on the theory of the capital budgeting evaluation techniques, the investments consideration will be analyzed upon Net Present Value (NPV), Payback period and Internal Rate of Return (IRR). The concepts will support ranking from the greatest project to less attractive one. First criteria that is used for ranking is the NPV method. It is considered as the most useful method because it is based on Cash Flows of the projects throughout their entire period. Of course it incorporates the time value of money concept and represents net value of the projects or net benefit that accrues to the company. Ranking assessment will consider as acceptable investment only projects with positive NPV. The second criterion is the IRR evaluation method. It is also an alternative to NPV method. Basically IRR is a discount rate that equates the present value of project’s expected cash flows to the initial invested amount. The successful ranking criteria for the acceptable projects, is to......

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...Case Study: The Investment Detective When reviewing the eight investment opportunities, I do believe that it is possible to rank the projects based on their cash flows. I also believe that ranking them just based on their cash flow would not be an accurate ranking. When you only consider the cash flow of an investment you only get a glimpse of the excess cash flow the company can profit from over the initial investment. Just looking at the cash flow does not take into consideration the account the time of money and is not a great way to make a decision about investments because different companies have different cash on hand needs. When looking at cash flow, I would rank the investments, from best to worst as 3, 5, 8, 4, 1, 7, 6, and 2. There are several criteria that could be used to analyze the investments to see which would be the best choice. You could use the payback method, net present value (NPV), internal rate of return (IRR), and the profitability index (PI). The payback method determines the length of time it will take to recover the initial investment also known as the payback period (Gabriel). A certain amount of time is chosen for the project to payback the initial investment. An easy way to think of the payback method is the length of time it will take to break even (Gabriel). The NPV is the difference between the cost of an investment and the market value (Gabriel). NPV measures the value that is added by choosing to do an investment. NPV is......

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...For the exclusive use of S. YAN ￼UV0072 Version 2.2 ￼THE INVESTMENT DETECTIVE The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm’s capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital-budgeting analyst, therefore, is necessarily a detective who must winnow bad evidence from good. Much of the challenge is in knowing what quantitative analysis to generate in the first place. Suppose you are a new capital-budgeting analyst for a company considering investments in the eight projects listed in Exhibit 1. The chief financial officer of your company has asked you to rank the projects and recommend the “four best” that the company should accept. In this assignment, only the quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive. All the projects require the same initial investment, $2 million. Moreover, all are believed to be of the same risk class. The firm’s weighted average cost of capital has never been estimated. In the past, analysts have simply assumed that 10% was an appropriate discount rate (although certain officers of the company have recently asserted that the discount rate should be much higher). To stimulate your analysis, consider the following......

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...Financial Management (BUSI 640) Professor Faulkender Investment Detective Case Questions The purpose of this case is to practice estimating the value created from taking on different projects and how those values change given differences in rates of return and project duration. We will look at different ways of evaluating capital budgeting decisions and see why Net Present Value (NPV) generates better decisions than other methods. Ignore the questions provided in the case itself. the Return on Investment (Excess of cash flow over initial investment divided by the initial investment). |No. |Project |Return on Investment | |1 |3 |400.00% | |2 |5 |110.00% | |3 |8 |107.50% | |4 |4 |78.05% | |5 |1 |65.50% | |6 |7 |28.00% | |7 |6 |10.00% | |8 |2 |8.25% | the payback period. |No. |Project ...

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...Peninah Machaga The Investment Detective Financial Administration FINC 5713-180 DR Roy Patin Fall 2013 10/22/2013. The Investment detective. The case is basically discussing the importance of Capital Budgeting and resource allocation. Capital budgeting is the whole process of analyzing projects and deciding which ones to accept and thus include in the capital budget. It is important for a company to evaluate proposed projects accurately because there are delicate issues that can obscure the best investment issues. Analyzing project proposals require skills, effort and time therefore, analyst should be in a position to know what quantitative analysis he is to generate. Required To Rank the eight projects and recommend the four best that company should accept. Assumptions * All the projects require the same initial investment of $2million with an assumption that, they have same risk class. * Weighted average cost of capital has never been estimated. * Discount rate is 10% . However most companies use NPV and IRR The first step in project analysis is to estimate the cash flow. * It is possible to rank the project by simply inspecting the cash flow. For example by the use of excess cash flow over the initial investment, we can be able to rank the projects according to how much each project has generated within a specific period. The higher the excess value, the best rank it is given. By the use of the illustration below, we can rank the project as follows Excess...

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...Questions: 1. Can you rank the projects simply by inspecting the cash flows? 2. What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why? 3. What is the ranking you found by using quantitative methods? Does this ranking differ from the ranking obtained by simply inspection of the cash flows? 4. What kinds of real investment projects have cash flows similar to the cash flow below? Project Cash Flows Project Number Initial Investment (In thousands of dollars) Year 1 ($2.000,00) $330,00 $330,00 $330,00 $330,00 $330,00 $330,00 $330,00 $1.000,00 ......

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...To: Dr. Map From: Phe Date: February 16, 2013 RE: Case 18 (The Investment Detective) Projects can be measured by inspecting cash flows alone but there are additional metrics than can be used to make the best recommendations. A brief description of each metric is provided below. * NPV: Net present value is the difference between the present value of the cash inflows and the cash outflows. If the NPV is positive a project should be accepted and if it is negative the project should be rejected. * IRR: Internal rate of return is the discount rate that results in a zero NPV for a project. * PI: Profitability index is equal to the present value of an investments future cash flows divided by its initial cost. A PI greater than one indicates that the present value of the investment’s future cash flows exceeds the cost of making the investment and the investment should be accepted. * PB: The payback period is the number of years of needed to recover the initial cash outlay required to make the investment. * EAC: The cost per year of each project. When completing an analysis, one must be aware of the advantages and disadvantages associated with each metric. NPV has the advantage is that it measures directly the increase in value that the project is expected produce. A possible disadvantage is that it requires an understanding of the time value of money. IRR provides a rate of return metric although there can be multiple rate of returns for......

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...MGT 4430 Fall 10 Investment Detective 08 Fall Investment Detective MGT 4430 With the realization that capital resources are limited, a prioritization of proposed projects must be established. Although most of these projects may satisfy the requirements to accept a project, due to capital budget constraints a company must choose which project they might best benefit from after analyzing the data associated with each project. After looking at Exhibits 1-6 with analysis of each project’s NPV, MIRR, Payback, and Profitability Index a list can be established below. Rank | Project Number | 1 | 7 | 2 | 4 | 3 | 3 | 4 | 5 | 5 | 1 | 6 | 6 | 7 | 2 | 8 | 8 | After looking at the data analysis in Exhibit 1, we are able to eliminate a few projects right away from the ranking of choices we would be interested in. After seeing that project 7 and 8 are mutually exclusive and 7 being a better project based on the quicker payback and initial returns. As well we can see that project 2 is in most regards, a terrible investment. We are able to see a negative NPV and an unacceptable MIRR which is lower than our desired discount rate. At a glance we are also able to see that project 6 is on the brink of acceptable which allows our investment team to accurately rank the three lowest projects on the list. One issue that must be regarded before being able to further progress through my reasons for rank is that the company has acknowledged the potential for......

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...Bruner: Case Studies in Finance: Managing for Corporate Value Creation, 4/e IV. Capital Budgeting and Resource Allocation 17. The Investment Detective © The McGraw−Hill Companies, 2003 CASE 17 The Investment Detective The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm’s capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital-budgeting analyst is necessarily, therefore, a detective who must winnow good evidence from bad. Much of the challenge is knowing what quantitative analysis to generate in the first place. Suppose you are a new capital-budgeting analyst for a company considering investments in the eight projects listed in Exhibit 1. The chief financial officer of your company has asked you to rank the projects and recommend the “four best” that the company should accept. In this assignment, only the quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive. All the projects require the same initial investment, $2 million. Moreover, all are believed to be of the same risk class. The weighted-average cost of capital of the firm has never been estimated. In the past, analysts have simply assumed that 10 percent was an appropriate discount rate (although......

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...The Investment Detective 1. Can you rank the project simply by inspecting the cash flow? 1) Project Ranking based on simple inspection of cash flows: | | | | Rank | Project No | Net Cash Flow($) | 1 | 3 | 8000 | 2 | 5 | 2200 | 3 | 8 | 2150 | 4 | 4 | 1561 | 5 | 1 | 1310 | 6 | 7 | 560 | 7 | 6 | 200 | 8 | 2 | 165 | As per net cash flow priority has been indicated above. But cash flow does not consider time value of money. So it is not good measure for rank different investment. 2. What criterion might you use to rank the projects? Which quantitative ranking methods are better? Why? Different quantitative methods are * Net Present Value * Internal rate of return * Payback period * Discounted payback period * Profitability Index NPV: IRR: 1) Project Ranking based on IRR: | | | | | Rank | Project No | IRR | 1 | 7 | 15% | 2 | 4 | 12.33% | 3 | 8 | 11.41% | 4 | 3 | 11.33% | 5 | 5 | 11.12% | 6 | 1 | 10.87% | 7 | 6 | 10% | 8 | 2 | 6.31% | Payback Period: 1) Project Ranking based on Pay Back Period: | | | | Rank | Project No | Pay Back Period | 1 | 6 | 0.91 | 2 | 7 | 1.88 | 3 | 2 | 2 | 4 | 8 | 6.04 | 5 | 4 | 6.05 | 6 | 1 | 6.06 | 7 | 5 | 7.14 | 8 | 3 | 15 | Discounted Payback Period: Project Ranking based on Discounted Pay Back Period: | | | | | | | | Rank | Project no. | Discounted Pay back period | | | | | 1 | 6 | 1 | | | | | 2 | 7 | 2.73...

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...Case Write-Up: The Investment Detective Case Summary The purpose of this case is to become a capital budgeting analyst and evaluate which set of free cash flows for 8 projects will result in the most effective investment for a firm’s capital. The objective given is to rank the four best that the company should accept. The case is broken down into three separate steps including the given information about estimated cash flows (inflows & outflows), determining the appropriate discount rate, and evaluating the cash flows using the IRR (Internal Rate of Return), MIRR (Modified Internal Rate of Return), NPV (Net Present Value), and other metrics. Each project is chosen solely on the basis of the quantitative analysis. Here are some factors to consider for this case: Each project has the same initial investment of $2 million; in addition, all are believed to be of the same risk class. The managers have determined that projects 7 and 8 are mutually exclusive. The issue is that the WACC has never been officially estimated and in the past the discount rate has been assumed at 10 percent (however, certain officers have asserted the discount rate to be higher). Ranking Projects Ranking projects simply through the inspection of cash flows is inadequate due to the time value of money and cost of capital of companies; the only piece of information that can be derived from looking at the cash flows is the amount of time it would take to be paid back (regular payback period).......

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...ranked according to the cash flow are as follows: 3 , 5 , 8 , 4 , 1 , 7 , 6 , 2 Based strictly on cash flow, the project that can generate the most excess cash over initial investments will be ranked first. 2) Criteria used are the no. of years that the investment amount was recovered and the discount rate. There are several evaluation methods: Accounting Rate of Return A project is considered acceptable if it is expected to produce an average profit relative to the level of investment at a rate at least equal to the firmÐ²Ð‚â„¢s desired return on investment. ARR = Average Profit / Initial Investment Payback Method Measure of the expected time before the initial investment will be recovered. Accept the project if payback is faster than the targeted payback. This method ignores the time value of the cash flows and their riskiness. Internal Rate of Return An investment project will be acceptable if IRR is greater than or equal to the required rate of return for that project. The higher the IRR, the better. Present Value Index Known as Ð²Ð‚Ñšprofitability indexÐ²Ð‚Ñœ. PVI was introduced for the purpose of ranking investment alternatives in the sense that it provides an indication of which alternative produces the highest return relative to the size of the investment. The highest PVI will be chosen. PVI = PV of Inflows / PV of Outflows Net Present Value NPV greater than or equal to zero indicates an acceptable project that at least......

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...Aplia: In addition to class preparation, for each chapter there are Aplia homework assignments, both practice and graded. Aplia is required of all students. Aplia’s homework questions and problems are tied to the textbook content and may not always agree completely with classroom discussions. Please read and comply with the Aplia instructions. For Aplia problems, use textbook formulas and 365 days in a year. Students are expected to complete all Aplia graded assignments by the specified due dates. There will be no extensions as the closing time is determined by computer. All assignments will be computer graded and scores and completion statistics will be reported by Aplia. Please see the Aplia documentation. Aplia assignments are the “homework” portion of the course grade and will be graded on the number of assignments completed and the percentage of correct answers as recognized by the computer. It is expected that students will spend approximately 2 to 3 hours, in addition to the time spent completing the Aplia assignments, preparing for each class. Additional time is required for the problems and analyses that are required. Attendance policy: There is a lot of material to be covered in this course. Therefore, it is important that every student attend every class, arriving on time. Attendance will be taken at the start of every class, and anyone not present will be marked absent. Three absences, for any reason, except University required activities, will result in a...

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...CASE STUDY The Investment Detective The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm’s capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital budgeting analyst is necessarily, therefore, a detective who must winnow good evidence from bad. Much of the challenges is knowing what quantitative analysis to generate in the first place. Supposed you are a new capital budgeting analyst for a company considering investments in the eight projects listed in Exhibit 1. The chief financial officer of your company has asked you to rank the projects and recommend the “four best” that the company should accept. Part I For the first part of this assignment only quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive. All projects require the same initial investment, $2,000,000. Moreover, all are believed to be of the same risk class. The weighted average cost of capital for the first part is 10%. To simulate your analysis, consider the following questions: 1. Can you rank the projects simply by inspecting the cash flows? We cannot rank the projects by simply inspecting the cash flows. We must bring all cash flows at the same point in time (present)......

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