Financial Management: NPV, IRR, and ARR Analysis

This article explains the financial management concepts of NPV, IRR, and ARR analysis with a case study. It also discusses the assumptions of CAPM and its calculation. The case study involves the calculation of NPV, IRR, and ARR for a project. The article concludes with the advantages and disadvantages of NPV analysis.

FINANCIAL
MANAGEMENT

TABLE OF CONTENTS
Question 1....................................................................................................................................1
Question 3....................................................................................................................................3
REFERENCES................................................................................................................................4

Question 1
a)
i)
Year Demand Price Sales
Fixed
cost
Variable
cost
each unit
Variable
cost
Cash
inflows
1 55000 30 1650000 150000 10 550000 950000
2 50000 30.6 1530000 150000 10.2 510000 870000
3 90000 31.212 2809080 150000 10.404 936360 1722720
4 10000 31.83624 318362.4 150000 10.61208 106120.8 62241.6
NPV
Year
Cash
inflows
cost of
capital
@
10%
Discounted
cash
inflows
1 950000 0.909 863636
2 870000 0.826 719008
3 1722720 0.751 1294305
4 62241.6 0.683 42512
Total discounted
cash inflow 2919462
Initial investment 2800000
NPV (Total
discounted cash
inflows - initial
investment) 119462
ii)
IRR
Year
Cash
inflows
0
-
2800000
1 950000
1

2 870000
3 1722720
4 62241.6
IRR 12%
iii)
ARR
Year
Cash
inflows
1 950000
2 870000
3 1722720
4 62241.6
Average profit or
cash inflow 901240.4
Average initial
investment 1400000
average initial
investment [(initial
investment + scrap
value) / 2] 64%
b)
From the valuation it can be identified that project can be financially acceptable as it has positive
net present value, higher ARR and IRR which are 64 & 12% respectively (Lima and et.al.,
2017).
c)
The biggest advantage is that it helps in getting information regarding future value of present
cash flow to have perspective of long terms so that rational decision can be taken (Fehrenbacher,
Kaplan and Moulang, 2020). Disadvantage is that presenting true investment risk premium
becomes difficult.
2

Question 3
a)
CAPM is an capital asset pricing model which reflects relationship between systematic risk and
expected return of stock. There are 3 assumptions of CAPM are as follows:
 Investors are risk averse which requires a diversification technique to mitigate the
associated threat with assets
 Investors makes the selection on the basis of risk and reward that is measured by mean &
variance of portfolio (Nurwulandari, 2021.). There is assumption that investor avoid
unsystematic risk and systematic remains only.
 Third assumption that investor can freely access information without paying any cost.
b)
CAPM Model calculation
Particulars Formula Figures
Rf (Risk free rate) 3%
Beta 1.5
Rm (market return) 5%
CAPM Rf + Beta (Rm - Rf) 5.3%
3

REFERENCES
Books and Journals
Fehrenbacher, D. D., Kaplan, S. E. and Moulang, C., 2020. The role of accountability in
reducing the impact of affective reactions on capital budgeting decisions. Management
Accounting Research. 47. p.100650.
Lima, A. C. and et.al., 2017. A qualitative analysis of capital budgeting in cotton ginning
plants. Qualitative Research in Accounting & Management.
Nurwulandari, A., 2021. Analysis Of The Relationship Between Risk And Return Using The
Capital Asset Pricing Model (Capm) Method At Kompas 100. Enrichment: Journal of
Management, 11(2), pp.528-534.
4