Financial Strategy: NPV, Payback Period, Profitability Index, IRR, and Net Present Value

This document discusses the financial strategy of NPV, payback period, profitability index, IRR, and net present value. It explains their significance in decision making and project viability. The document also covers sensitivity analysis, factors influencing the purchase of a new smartphone, and the impact of loss on sales of other models. The conclusion provides a summary of the findings.

Running Head: FINANCIAL STRATEGY 0
NPV

FINANCIAL STRATEGY 1
Contents
Introduction‘....................................................................................................................................2
Payback period.............................................................................................................................2
Profitability Index........................................................................................................................2
IRR...............................................................................................................................................3
Net Present Value.........................................................................................................................3
Sensitivity with respect to the price.............................................................................................4
Sensitivity with respect to the NPV.............................................................................................5
Factors to decide the purchase of the new smart phone...............................................................5
Effect of loss on sales of other models........................................................................................5
Conclusion.......................................................................................................................................6
References........................................................................................................................................7
Appendix 1.......................................................................................................................................9

FINANCIAL STRATEGY 2
Introduction‘
Corporate finance is the most crucial subject to work upon in the process of the accounting and
therefore this is the most important process from the point of view of the analysis and decision
making of the selection and the rejection of the project. In this report the detailed analysis of the
NPV, payback period, IRR as well as the profitability index have been undertake to determine
the violability of the project. Further the sensitivity analysis is also undertaken to determine the
minimum as well as the maximum possible risk a company can take while choosing the model
(Schrader, Piel and Breitner, 2018).
Payback period
While taking the decisions of the capital budgeting the payback period is the method of selection or the
rejection of the project. In simpler terms the payback period is the period of time required to recoup the
funds expended in the investment. Usually the payback period is expressed in years. Most of time the
longer payback periods is not accepted by the company. The payback period of the Emu Electronics
is 2.39 years and it showcases that the company is able to pay the cost of investment within the
period of 2.39 years. The advantage of calculating the payback period is its simplicity. The
disadvantage of the payback period is that ignores the concept of the time value of money
(Rusydiana and Al Parisi, 2016).
Profitability Index
Profitability index of the project is also known as the investment ratio which determines the
payoff to the investment of a proposed project. The tool is considered as the useful tool in giving
the ranks to the projects as it gives the value created per investment. The main advantages of the
profitability index are that it considers the time value of money which the payback period refuses

FINANCIAL STRATEGY 3
to do so (Pianosi and Wagener, 2015). Hence the liability of the payback period can be covered
by the company in calculating the profitability index of the project. Not only this, profitability
index of the project considers the analysis of all the cash flows and ascertains the rate of return of
the project with the high amount of accuracy. The biggest disadvantage of the profitability index
of the project is it cannot be applied when the two different models are of different useful life.
IRR
The internal rate of return is a metric which is a measurement, which are a concept of budgeting
and the estimation of the profitability of potential investments. The internal rate of return is the
discounted factor which is used to determine the value of the annual cash flows along with the
initial investment (Loubière, Jourdan, Siarry and Chelouah, 2016). The corporations are utilising
the capital budgeting scenario to compare the profitability of the projects and this will determine
the alternatives of the feasible projects to the company. A project can be considered as the good
investment if the IRR is greater than the rate of return. The advantages of the IRR is the ease to
calculate. The simplicity is such that if the IRR is greater than the project shall be accepted and if
the case is reversing than the project shall be rejected. The time value of money is being
considered in case of calculating the IRR. There is no requirement of finding the hurdle rate or
the required rate of return. The disadvantages of the company the economies of the scale are
ignored (Ismail, 2016).
Net Present Value
The net present value method of the project is the value or the method which is the good way to
analyse the profitability of an investment in a company (Iooss and Lemaître, 2015). It carries a
few unique advantages as well as the disadvantages that may be either useful or not useful for
making the decisions. The basic criteria of the Net present value of the company reflect the fact

FINANCIAL STRATEGY 4
that the future value is not much worthy as in comparison to the present value of the project. The
biggest merit of this method is net present value are that it takes into account the basic idea of the
present value. Secondly the NPV method also tells whether the investment in the current model
will provide the future value or not and if yes how much in terms of the dollars. The final
advantage of the net present value of the model is that it takes into the consideration the cost of
the capital and risk associated with the future projections. On the contrary the biggest
disadvantage of the net present value of the method is that the cost of capital requires some guess
work and cannot be calculated in the accurate manner (Gabriel, et al 2016).
Sensitivity with respect to the price
In the evaluation of an investment project the cash flows are projected and these cash flows are
mainly dependent on the expected revenue and costs. The expected revenue is the combination
of the sales units and the sale price and the volume of the sales will be dependent upon the
market size and the market share of the company. Sensitivity analysis is one of the ways of
analysing the net present value of the project and the analysis is done on the basis of the one of
the changes in the variables. There are following steps involved in the sensitivity analysis which
is underlined below (Fracassi, 2016).
 First of all the variables that have the major influence are classified on the projects NPV
or IRR.
 Secondly the relationship between the variables is determined (Shelley, Boo and Luyties,
2018).
 Thirdly the impact of the change in the variables of the projects NPV is determined.

FINANCIAL STRATEGY 5
As determined in the question how sensitive the NPV is with respect to the change in the price of
the smart phone the percentage change of the project is -11.67% and this suggests that the price
cannot be declined by more than 5% (Damodaran, 2016).
Sensitivity with respect to the NPV
In terms of the change in the quantity sold by the Emu Electronics that the percentage change is -
6.74% and hence the NPV is quite sensitive but not in terms of the existing NPV. Further, these
analysis will determine the how much value the company can make and at what rate of
provision. The company is sensitive enough but not until the figure is negative (Willigers, Jones,
and Bratvold, 2017).
Factors to decide the purchase of the new smart phone
Emu electronics projects shall be accepted by the company as the annual cash flows were
calculated after adding back the depreciation. Thereafter the payback period of the company is
the 2.36 days and hence according to the payback period of the Emu Electronics can be accepted
by the company. Further the IRR is calculated at 27.39%. This suggests that the project shall be
accepted by the company. In terms of the net present value the value is positive at present at
82582091 and hence the project is a viable option from the point of view of the investment
(Schrader, Piel and Breitner, 2018).
Effect of loss on sales of other models
If the Emu Electronics loses the sales on the other models because of the introduction of the new
model, this will have a major impact on the sales of the company. Since the profit which was
being incurred by the company with the help of the existing models that would require the equal
compensation from the production of the new models. To make sure the firm does not leave the

FINANCIAL STRATEGY 6
opportunity cost of the profit from existing smartphone, the firm’s management must make an
incremental analysis to make sure nothing is left behind (Willigers, Jones and Bratvold, 2017).
Conclusion
From the above of the analysis, the net present value, IRR, and the profitability index are the
basis on which the projections are undertaken. Therefore from the above analysis it can be
concluded that the Emu Electronics shall accept the model and thereafter the compensation shall
be made for the sales from the other models. Also the company shall not restrict the selection
process just on the basis of the IRR or NPV or profitability index rather a combination of two
will give the exact accuracy of the selection of the project.

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References
Bora, B., 2015. Comparison between net present value and internal rate of return. International
Journal of Research in Finance and Marketing, 5(12), pp.61-71.
Damodaran, A., 2016. Damodaran on valuation: security analysis for investment and corporate
finance (Vol. 324). John Wiley & Sons.
Fracassi, C., 2016. Corporate finance policies and social networks. Management Science, 63(8),
pp.2420-2438.
Gabriel Filho, L.A., Cremasco, C.P., Putti, F.F., Goes, B.C. and Magalhaes, M.M., 2016.
Geometric Analysis of Net Present Value and Internal Rate of Return. Journal of Applied
Mathematics & Informatics, 34, pp.75-84.
Iooss, B. and Lemaître, P., 2015. A review on global sensitivity analysis methods. In Uncertainty
management in simulation-optimization of complex systems (pp. 101-122). Springer, Boston,
MA.
Ismail, R., 2016. Impact of Liquidity Management on Profitability of Pakistani Firms: A Case of
KSE-100 Index. International Journal of Innovation and Applied Studies, 14(2), p.304.
Loubière, P., Jourdan, A., Siarry, P. and Chelouah, R., 2016. A sensitivity analysis method for
driving the Artificial Bee Colony algorithm's search process. Applied Soft Computing, 41,
pp.515-531.
Pianosi, F. and Wagener, T., 2015. A simple and efficient method for global sensitivity analysis
based on cumulative distribution functions. Environmental Modelling & Software, 67, pp.1-11.

FINANCIAL STRATEGY 8
Rusydiana, A. and Al Parisi, S., 2016. The measurement of Islamic bank performance: A study
using maqasid index and profitability. Global Review of Islamic Economics and Business, 4(1),
pp.001-014.
Schrader, P., Piel, J.H. and Breitner, M.H., 2018. Decoupled Net Present Value—An Alternative
to the Long-Term Asset Value in the Evaluation of Ship Investments?. In Operations Research
Proceedings 2017 (pp. 271-276). Springer, Cham.
Shelley, A.S., Boo, S.Y. and Luyties, W., 2018. Net Project Value Assessment of Korean
Offshore Floating Wind Farm using Y-Wind Semi Platform. In Korea Wind Energy Association
(KWEA), Fall Conference.
Willigers, B.J., Jones, B. and Bratvold, R.B., 2017. The Net-Present-Value Paradox: Criticized
by Many, Applied by All. SPE Economics & Management.

FINANCIAL STRATEGY 9
Appendix 1
Estimated Sales
Years 1 2 3 4 5
Sales 31040000 51410000 42195000 37830000 26190000
variable costs 13120000 21730000 17835000 15990000 11070000
Contribution 17920000 29680000 24360000 21840000 15120000
less: Fixed costs 5100000 5100000 5100000 5100000 5100000
Profits before depreciation 12820000 24580000 19260000 16740000 10020000
less: Depreciation 4928571 4928571 4928571 4928571 4928571
Profits after depreciation 7891429 19651429 14331429 11811429 5091429
Less taxation 2367429 5895429 4299429 3543429 1527429
Profits after taxation 5524000 13756000 10032000 8268000 3564000
Annual cash flows after
adding back depreciation
10452571 18684571 14960571 13196571 8492571
Payback Period Annual Cash
Flows
Cumulative
cash flows
0 -34500000
1 10452571 -24047429
2 18684571 -5362857
3 14960571 9597714
4 13196571 22794286
5 8492571 31286857
Payback Period 2.36
Profitability Index
Present value 2.39
Initial investment
IRR
Annual Cash
Flows
0 -34500000
1 10452571
2 18684571
3 14960571
4 13196571

FINANCIAL STRATEGY 10
5 8492571
IRR 27.39%
Net Present value Rate of
Return
@12%
Net Present
value
0 -34500000 1.0000 34500000
1 10452571 0.8929 9332653
2 18684571 0.7972 14895226
3 14960571 0.7118 10648639
4 13196571 0.6355 8386660
5 8492571 0.5674 4818913
Net Present Value 82582091
Sensitivity check: Factor- Units sold
Assume 10% decrease in units sold -10%
Estimated Sales
Years 1 2 3 4 5 Total
Units sold 57600 95400 78300 70200 48600
Price 485 485 485 485 485
Sales 27936000 46269000 37975500 34047000 23571000 169798500
variable costs 11808000 19557000 16051500 14391000 9963000 71770500
Contribution 16128000 26712000 21924000 19656000 13608000 98028000
less: Fixed costs 5100000 5100000 5100000 5100000 5100000 25500000
Profits before depreciation 11028000 21612000 16824000 14556000 8508000 72528000
less: Depreciation 4928571 4928571 4928571 4928571 4928571 24642857
Profits after depreciation 6099429 16683429 11895429 9627429 3579429 47885143
Less taxation 1829829 5005029 3568629 2888229 1073829 14365543
Profits after taxation 4269600 11678400 8326800 6739200 2505600 33519600
Annual cash flows after
adding back depreciation
9198171 16606971 13255371 11667771 7434171
Net Present value Rate of Net

FINANCIAL STRATEGY 11
Return
@12%
Present
value
0 -34500000 1.0000 34500000
1 9198171 0.8929 8212653
2 16606971 0.7972 13238976
3 13255371 0.7118 9434912
4 11667771 0.6355 7415080
5 7434171 0.5674 4218349
Net Present Value 77019969
Existing NPV 82582091
Change -5562122
% change -6.74%
Sensitivity check: Factor- Unit
Price
Assume 10% decrease in unit
price -10%
Estimated Sales
Years 1 2 3 4 5 Total
Units sold 64000 106000 87000 78000 54000
Price 436.5 436.5 436.5 436.5 436.5
Sales
2793600
0
4626900
0
3797550
0
3404700
0
2357100
0
16979850
0
variable costs
1312000
0
2173000
0
1783500
0
1599000
0
1107000
0 79745000
Contribution
1481600
0
2453900
0
2014050
0
1805700
0
1250100
0 90053500
less: Fixed costs 5100000 5100000 5100000 5100000 5100000 25500000
Profits before depreciation 9716000
1943900
0
1504050
0
1295700
0 7401000 64553500
less: Depreciation 4928571 4928571 4928571 4928571 4928571 24642857
Profits after depreciation 4787429
1451042
9
1011192
9 8028429 2472429 39910643
Less taxation 1436229 4353129 3033579 2408529 741729 11973193
Profits after taxation 3351200
1015730
0 7078350 5619900 1730700 27937450
Annual cash flows after adding
back depreciation
8279771 1508587
1
1200692
1
1054847
1
6659271

FINANCIAL STRATEGY 12
Net Present value Rate of
Return
@12%
Net
Present
value
0
-
3450000
0 1.0000
3450000
0
1 8279771 0.8929 7392653
2
1508587
1 0.7972
1202636
4
3
1200692
1 0.7118 8546290
4
1054847
1 0.6355 6703744
5 6659271 0.5674 3778649
Net Present Value
7294770
1
Existing NPV
8258209
1
Change
-
9634390
% change -11.67%