Corporate Finance Module: Analyzing Investment Methods Assignment

This assignment delves into the core concepts of corporate finance, specifically focusing on the methods used to analyze potential investments. The solution addresses two key questions: the various techniques available for investment analysis and the justification for the superiority of the Net Present Value (NPV) method. The assignment outlines several methods including Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period (PBP), Discounted Cash Flow (DCF), Profitability Index (PI), and Accounting Rate of Return (ARR), providing a concise explanation of each. The solution then argues for the supremacy of NPV, highlighting its ability to rank projects, account for all cash flows, consider the cost of capital and risk, and provide a clear measure of value creation. The assignment concludes by referencing several academic sources to support the analysis.

Running head: CORPORATE FINANCE
Corporate Finance
Name of the Student:
Name of the University:
Author’s Note:
Course ID:

1CORPORATE FINANCE
Table of Contents
Answer to Question 1:.....................................................................................................................2
Answer to Question 2:.....................................................................................................................3
References:......................................................................................................................................4

2CORPORATE FINANCE
Answer to Question 1:
The methods that an organisation could use for analysing a potential investment include
the following:
 Net present value (NPV) is the amount of estimated cash flows discounted to the present
and it is used by the accountants, investors and analysts for analysing the profit margin
of proposed investments and projects.
 Internal rate of return (IRR) is the rate of interest at which the NPV of all positive and
negative cash flows from an investment or project is zero. If IRR is more than the
required rate of return or cost of capital, the project could be undertaken and vice-versa.
 Payback period (PBP) is the time needed to earn back investment cost made by an
organisation in any particular project (Andor, Mohanty & Toth, 2015). When PBP is
lower than the economic life of a project, the project should be undertaken and vice-
versa.
 Discounted cash flow (DCF) is a method of valuation utilised for projecting the value of
investment depending on future cash flows.
 Profitability index (PI) assists in ranking investments along with deciding the best
investments, which need to be undertaken. If the value is greater than 1, the project has
to be accepted and vice-versa.
 Accounting rate of return (ARR) could be defined as the ratio of projected accounting
profit of a project to average investment incurred in a project. A higher figure is always
favourable for any investment or project when it comes to accepting the same (Bierman
Jr & Smidt, 2014).

3CORPORATE FINANCE
Answer to Question 2:
NPV is deemed to be a superior method of analysing the cash flows from any investment
or project, since it has the ability of ranking projects of various sizes over different periods in
order to ascertain the most suitable course of action (De Andrés, De Fuente & San Martín, 2015).
NPV does not assume that all cash flows would be reinvested at IRR, which is not possible. By
reinvesting the cash flows at IRR, the cash flows are invested back from the project into the
market at the similar rate of the rate of return of the project. Therefore, another investment needs
to be found yielding the same return for reinvestment, which is extremely difficult.
NPV takes into consideration all cash flows unlike payback period or discounted payback
period that ignores the cash flows beyond the payback period. This method provides an idea
whether an investment would create value for the investor or the organisation and the amount in
terms of money. Finally, NPV takes into account the cost of capital and the risk evident in
making future estimations. Generally, an estimation of cash flows 10 years into the future is
mainly less certain compared to the anticipated cash flows next period. The cash flows, which
are estimated further into the future, have lower impact on NPV in contrast to the more estimated
cash flows that occur in past periods (Rossi, 2014). Therefore, NPV is deemed to be the superior
measure of investment compared to the other investment appraisal techniques.

4CORPORATE FINANCE
References:
Andor, G., Mohanty, S. K., & Toth, T. (2015). Capital budgeting practices: A survey of Central
and Eastern European firms. Emerging Markets Review, 23, 148-172.
Bierman Jr, H., & Smidt, S. (2014). Advanced capital budgeting: Refinements in the economic
analysis of investment projects. Routledge.
De Andrés, P., De Fuente, G., & San Martín, P. (2015). Capital budgeting practices in
Spain. BRQ Business Research Quarterly, 18(1), 37-56.
Rossi, M. (2014). Capital budgeting in Europe: confronting theory with practice. International
Journal of Managerial and Financial Accounting, 6(4), 341-356.