Managerial Finance: NPV, IRR, Payback Period, ARR, Profitability Index and Sensitivity Analysis

Running Head: FINANCE
Managerial finance

Finance 1
Question 1
Part1: Net Present Value
Year
Cash flows before
loan payment
Principle
(Refer:
appendix
1) Interest
Net Cash
Flows
PVF@
12.5% Present Value
0
$
-2.40
$ -
2.40 1.000
$ -
2.40
1
$
1.04
$
0.21
$
0.07
$
0.76 0.889
$
0.67
2
$
0.60
$
0.27
$
0.02
$
0.32 0.790
$
0.25
3
$
0.97
$
0.27
$
0.02
$
0.68 0.702
$
0.48
4
$
0.55
$
0.27
$
0.02
$
0.27 0.624
$
0.17
5
$
0.70
$
0.19
$
0.10
$
0.42 0.555
$
0.23
5
$
0.24
$
- $ -
$
0.24 0.555
$
0.13
NP
V
$ -
0.46
Part 2: Internal Rate of Return
Year Cash flows
0
$
-2.40
1
$
0.76
2
$
0.32
3
$
0.68
4
$
0.27
5
$
0.42
5
$
0.24
IRR 3.85%
Part 3: Payback Period
Year Cash flows Cumulative Cash Flows
0 $ - $ -

Finance 2
2.40 2.40
1
$
0.76
$ -
1.64
2
$
0.32
$ -
1.33
3
$
0.68
$ -
0.64
4
$
0.27
$ -
0.38
5
$
0.42
$
0.04
5
$
0.24
$
0.28
Payback
period(years) 3.10
Part 4: Average Rate of return
Average net profit/ Average investment
Year Cash flows Depreciation Interest Net profit
1 $ 1.04
$
0.96
$
0.07 $ 0.01
2
$
0.60
$
0.58
$
0.02 $ 0.01
3
$
0.97
$
0.35
$
0.02 $ 0.60
4
$
0.55
$
0.21
$
0.02 $ 0.33
5
$
0.70
$
0.12
$
0.10 $ 0.48
$ 1.43
Average Profits = 0.012 + 0.008 + 0.603 + 0.327 + 0.483 =$ 0.286
5
Average Investment= salvage value + 0.5 (Initial investment – salvage value)
= .0240 + 0.5 (2.40-.0240)
= $ 1.32
Accounting Rate of Return= 22%
Part5: Profitability Index

Finance 3
NPV + Initial Investment/ Initial Investment
NPV
$
-0.46
Initial Investment
$
2.40
NPV+ Initial investment
$
1.94
P.I 0.81
Part 6: Analysis
According to the calculation done, NPV of the project is negative that is $ -0.46. A negative
NPV means project is not able to generate sufficient cash inflows and is not considered to be
profitable for the purpose of investment. The project has a negative NPV which implies that it
will not generate enough cash inflows to recoup its initial outlay. Hence, it will be
recommended not to invest in such project (Agarwal, 2013).
According to the policy DCL has of repaying its capital investment within 2.50 years, the
payback period calculated for the project is much more. The proposal has a payback period of
3.10 years which states that it will take 3 years and 10 months to repay the initial investment.
Once the period is over, the project will start generating returns. Hence as per the policy, it
should not be accepted (Bierman & Smidt, 2012).
As far as IRR is concerned, it is very much less than the project’s required rate of return of
12%. The IRR is 3.85% and is considered as a discount rate on which project earned no profit
and loss. So it should be rejected. However, it’s ARR of 22% is more than the desired rate,
which gives a valid reason to accept the project from ARR point of view (Agarwal, 2013).
The last calculative part include the determination of profitability index which is 0.81 of the
project. For a proposal to be accepted by the managers, its P.I should be more than one. As it
is clear that the P.I of the project is less than one so it should be rejected. Four out of five
capital budgeting techniques shows the result that the project is not appropriate for
investment. These are mostly used techniques which measures the viability of an investment
proposal. So it will be recommended not to invest in such project (Bierman & Smidt, 2012).
Treatment of loan repayment and salvage value:
The entire instalment amount per year is deducted from the cash flows to reach at net cash
flows to determine the net present values, Profitability index, and internal rate of return and