Discuss About The Principles Applications Financial Management.
The objective of the given report is to analyse the given project with the use of suitable capital budgeting techniques such as NPV, IRR and payback period. Using these techniques and the information of the projected cash flows associated with the project, the financial viability of the project can be ascertained. The application of the various capital budgeting techniques to the given project is indicated below.
NPV (Net Present value)
The net present value for the project has been computed using the 10% discount rate taking into consideration the expected cash over during the project years. The computation is indicated below.
From the above computations, it is apparent that the NPV for the project is $42,348. Since the NPV of the project is positive, hence it implies that the given project is acceptable in regards to this criterion. This is because such a project would increase the shareholders’ wealth owing to present value of cash inflows being more than corresponding value of cash outflows (Damodaran, 2010).
IRR (Internal Rate of Return)
The IRR is defined as that discount rate for which the NPV of the underlying project becomes equal to zero. The IRR computation for the given project is indicated below.
The decision rule with regards to IRR is that the project is considered feasible if the discount rate is lower than the IRR (Petty et. al., 2015). In the given case, the discount rate or cost of capital for the project is 10% while the IRR computed above is 32.40%. Hence, it can be concluded that the project is financially feasible and the company should proceed with the same.
The payback period refers to the amount of time that is required in order to recover the initial investment that is put in the project. For instance, in the project under consideration, the initial investment amounts of R50,000 and based on the computation of payback period in excel, it is estimated that the payback period amounts to three years. These computations are as highlighted below.
Based on the payback period also, the project seems financially feasible considering that the project life is five years. It is noteworthy that one of the drawbacks associated with payback period is that unlike the NPV and IRR computation, payback period does not take into consideration the time value of money and hence is considered comparatively inferior (Brealey, Myers & Allen, 2012).
The given project has been evaluated for financially feasibility using three capital budgeting techniques namely NPV, IRR and Payback Period. Based on this analysis, it would be recommended that the given project must be accepted owing to the following reasons (Damodaran, 2010).
- The NPV of the project is positive or greater than zero.
- The IRR of the project is greater than the cost of capital of the project.
- The payback period is lesser than the estimated life of the project.
Based on the above observations, it may be concluded that the given project would enhance value for the shareholders’ and hence must be executed by the company.
Brealey, R. A., Myers, S. C., & Allen, F. (2012) Principles of corporate finance, 2nd ed. New York: McGraw-Hill Inc.
Damodaran, A. (2010). Applied corporate finance: A user’s manual 3rd ed. New York: Wiley, John & Sons.
Petty, J.W., Titman, S., Keown, A., Martin, J.D., Martin, P., Burrow, M., & Nguyen, H. (2015). Financial Management, Principles and Applications, 6th ed.. NSW: Pearson Education, French Forest Australia.