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22 Feb
2021

Drawback of non-discounted cash flow does not consider TVM and the rate of return, and the discounted cash flow does not examine…

Category:ACADEMICIAN

SOLUTION AT Australian Expert Writers

The investment Detective
Answer Q1:
We can rank the projects by simply inspecting the cash flows (mention bellow), yet it’s not a good measure to rank them.
We can’t 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 Ranking by simply inspecting the cash flows:
Rank
1st
2nd
3rd
4th
5th
6th
7th
8th
Projects
3
5
8
4
1
7
6
2
Cash Flows
$10,000
$4,200
$4,150
$3,561
$3,310
$2,560
$2,200
$2,165
Answer Q2:
In order to rank these projects, in a purely quantitative manner, we used the following for the 8 projects:
Net Present Value (NPV)
Internal Rate of Return (IRR)
Payback Period (PP)
Profitability Index (PI)
Net Present Value (NPV)
Year
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Project 7
Project 8

($2,000)
($2,000)
($2,000)
($2,000)
($2,000)
($2,000)
($2,000)
($2,000)
1
300.00
1,514.55

145.45
254.55
2,000.00
1,090.91
(318.18 )
2
272.73
276.03

165.29
231.40

743.80
(49.59)
3
247.93
123.97

262.96
210.37

225.39
45.08
4
225.39


269.79
191.24

61.47
239.05
5
204.90


268.24
173.86

43.46
434.64
6
186.28


248.37
158.05


677.37
7
169.34


226.82
143.68


1,154.61
8
466.51


207.13
130.62



9



189.15
118.75



10



172.72
107.95



11



157.72
98.14



12



143.70
89.22



13



130.64
81.11



14



119.03
73.73



15




67.03



S PV(CF)
2,073.086
1,914.545
2,393.920
2,228.222
2,129.702
2,000
2,165.041
2,182.984
NPV
73.086
(85.455)
393.920
228.222
129.702

165.041
182.984
Rank
6th
8th
1st
2nd
5th
7th
4th
3rd
Internal Rate of Return (IRR)
Projects
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Project 7
Project 8
IRR
10.87%
6.31%
11.33%
12.33%
11.12%
10.00%
15.26%
11.41%
Rank
6th
8th
4th
2nd
5th
7th
1st
3rd
All of these projects are accepted except Project 2 because its cost of capital has higher percentage than the percentage project internal rate of return. Moreover, Project 6 will be a subject of be in different because the cost of capital equal to internal rate of return, which lead to break even project.
Payback Period (PP)
In Payback Period there are two method, non-discounted cash flow and discounted cash flow. Drawback of non-discounted cash flow does not consider TVM and the rate of return, and the discounted cash flow does not examine all the cash flows.
Projects
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Project 7
Project 8
Payback Year
7
2
15
6
8
1
2
7
Payback
2,310
2,000
10,000
1,977
2,240
2,200
2,100
4,150
Discounted Payback
1,606.58
1,790.58
2,393.92
1,360.10
1,493.78
2,000
1,834.71
2,182.98
Decision (DPP)
Reject
Reject
Accept
Reject
Reject
Be in different
Reject
Accept
Rank
6th
5th
1st
8th
7th
3rd
4th
2nd
Profitability Index (PI)
Projects
Project 1
Project 2
Project 3
Project 4
Project 5
Project 6
Project 7
Project 8
PI
 1.037
0.957
1.197
1.092
1.065
1.000
1.083
1.0773
Rank
6th
8th
1st
2nd
5th
7th
3rd
4th
All the projects will be undertaken except for project 8 since it is mutually exclusive with project 7, and project 6 and 2 will not be undertaken since they have IRR that is less than the 10%, the discount rate. Project 1 also might not be taken since “certain officers of the company have recently asserted that the discount rate should be much higher.”
Rank
1st
2nd
Project
8
7
IRR
11.41%
15.26%
NPV
182.98
165.04
Since these two projects are mutually exclusive and have the IRR above 10%, Project 8 will be chosen because it has higher NPV.
Rank
1st
2nd
3rd
4th
5th
6th
7th
8th
Project
3
4
8
7
5
1
6
2
PI
1.197
1.092
1.083
1.0773
1.065
1.037
1.000
0.957
All the projects will be undertaken except for project 7 since it is mutually exclusive with project 8, and project 6 and 2 will not be undertaken since they have PI’s equal to 1 and 0.957, because they are not greater than 1.
Selected Projects as per the quantitative methods as follow:
Rank
1st
2nd
3rd
4th
Projects
Projects 3
Projects 4
Projects 8
Projects 5
 Comparing the quantitative methods, we noticed that project 3 scored 1st four times using simple inspections of cash flows, NPV, PP, and PI. Project 7 however, scored 1st only through using the IRR method. Looking on the last ranked projects, project 2 has scored last 4 times using simple inspections of cash flows, NPV, IRR, and PI.
 Net Present Value is considered the best approach since it:
 Uses Cash Flows.
 Uses all the Cash Flows of the project.
iii.    And discounts the Cash Flows properly.
And through using the NPV approach, Project 3 got the highest NPV, 393.92, and then comes 4, 8, 5 and 1.
Answer 3:
Selected Projects as per the quantitative methods as follow:
Rank
1st
2nd
3rd
4th
Projects
Projects 3
Projects 4
Projects 8
Projects 5
The above table showing that it is absolutely the rank will be differ from the ranking obtain by simple inception of the cash flow
Answer 4:
Project 1    Bonds
Project 2    Equipment Depreciation
Project 3    Land or real assets investments
Project 4    Diary factory that incur agricultural costs
Project 5    Car Loan
Project 6    Stock
Project 7   Trucks Depreciation
Project 8   Construction projects

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