RRT Project: Project Evaluation

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RRT Project: Project Evaluation
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Discounted Cash Flow (DCF) method of asset valuation
Discounted Cash Flow (DCF) method is a valuation technique used to determine the present
value of an investment project using its future cash flows. As the name dictates, the present value
of future cash flows is calculated using discount rates. The objective of DCF is to determine the
amount an investor would receive today after investing in a project that is expected to yield
returns in the future. DCF is made of the time value of any technique: A dollar today has more
value than a dollar tomorrow. Investors use DCF to decide whether or not to invest in a project. A
project is accepted when the DCF is higher than the initial cash outflow. On the other hand, a
project is rejected when the DCF is lower than the initial cash outflow (Baker & Martin, 2011, p.
56).
Some of the discounted cash flow valuation methods used to evaluate future projects are Net
Present Value (NPV) and Internal Rate of Return (IRR). Besides the DCF methods, investors also
rely on Payback Period (PBP) and Accounting Rate of Return (ARR). This study seeks to
calculate the present value of the future cash flows that would be received by the Auditizz
Electronics for investing in the ‘real-time translator’ (RTT) project (English, 2011, p. 87).
1) The non-discounted payback period (PBP) of the project
Non-discounted payback period technique does not consider the time value of money. The PBP
assumes that a dollar tomorrow has the same value as a dollar today. PBP evaluates the break-
even period of a project. That is, the time it would take for a project to generate the initial cash
outflow (Fabozzi & Markowitz, 2011, p. 54). The Auditizz Electronics will invest in the RTT
project for four years. The project period expires at the end of the fourth year. According to

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appendix two (in the appendices section), it would take 4.24 years to recover the initial cash
outflow of 4122,775,000.
2) The net Accounting Rate of Return (ARR) of the project
The Accounting Rate of Return (ARR) is also a non-discounted project evaluation method used
by investors to evaluate the viability of a project. ARR is calculated by dividing the expected
average annual profit by the initial investment (Damodaran, 2002, p. 117). The average yearly
profit of the project over the four years is $ 18,164,072.5. On the other hand, the average initial
investment of the project is $71,637,500. The ARR is 25.4% after dividing the two values.
Therefore, The Auditizz Electronics will have a 25.4% of the profit from every dollar invested in
the project.
3) Calculate the NPV and IRR of the project of the project
Both the NPV and the IRR project valuation techniques consider the time value of money. The
viability of a project is determined using the present value of the discounted future cash flows.
NPV is calculated by finding the difference between the discounted future cash flows and the
initial cash outflow. A project is accepted if it has a positive NPV and rejected if it has a negative
NPV. On the other hand, IRR is used to test the profitability of a project by comparing the IRR
and the cost of capital. A project should be accepted if the IRR is higher than the cost of capital;
otherwise, it should be rejected (Bierman & Smidt, 2014, p. 71).
The NPV for the RRT project (as shown in the appendices section) is. $4,733,783.9 Therefore,
the project should be accepted. Likewise, the IRR of the project is 12.5489% while the
company’s cost of capital is 11%. Therefore, the projected should be accepted because the IRR is
higher than the cost of capital.

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4) The NPV’s sensitivity to changes in price and quantity sold
Sensitivity analysis is based on the “what if” scenario. The technique can be used to test how
sensitive the NPV is to the changes in the product price or quantity sold. A positive NPV portrays
a project as viable. However, NPV is calculated based on future projections, which can be
influenced by market forces. For example, a company be forced to revise the product price by
either reducing or increasing it (Levy, 2015, p. 88). The price of a product is reduced if the sales
are low or the competition is high. Therefore a company can be forced to reduce the price to
increase its sales volume and have a competitive advantage. The same case applies to the quantity
sold. An increase in the price or quantity sold would lead to an increase in the NPV when all the
other factors remain constant. On the other hand, a decrease in the price or quantity sold would
lead to a reduction of the NPV (Houghton, et al., 2010, p. 111). However, the percentage of such
changes should be calculated to determine whether or not the project is still viable after the
reductions in price and quantity sold.
Auditizz Electronics projects that it will sell 105, 000, 156,000, 189,000 and 175,000 pieces of
RRT is the first, second, third and fourth year respectively. The price per unit of RRT will be
$850 in the first year and increase by 3% each year afterwards. Based on the prices and quantities
sold, the company will have a positive NPV of $4,733,783.9
a) What if the price reduces by 10% over the four years
A reduction of the price by 10% of the four years would result in $765, $787.95, $ 811.62, and
$836.01 between year one and year four respectively. A 10% decrease in price would lead to a
negative NPV of $ -18,815,057.92.