MBA-622 - Financial Management

8/20/2019 MBA-622 - Financial Management

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MBA 622 - Financial Management

$able of Contents

Part 1 - Evaluate both the projects:............................................................................................1

Part 2 Evaluation o! techni"ues...............................................................................................#

Part $ - Multiple %hoice &uestions an' (hort Ans)ers.............................................................*

+e!erences..................................................................................................................................,

1

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%art & ' ()aluate both the *rojects:

%aybac+ *eriod

%roject S

nvestment 1//0

Balance as at !irst ear en' $/0

Balance as at secon' ear en' 2/

Balance as at thir' ear en' /

t )ill ta3e 1 ear an' 4$/ 5 #/0 127 8 9.2 months to pa bac3 )hich is 1 ear an' *

months )hen )e roun' up.

%roject ,

nvestment 1//0

Balance as at !irst ear en' ,/0

Balance as at secon' ear en' $/0

Balance as at thir' ear en' #/

t )ill ta3e 2 ears an' 4$/ 5 */0 127 8 .# months to pa bac3 )hich is 2 ears an' #

months )hen )e roun' up.

n terms o! pabac3 perio' metho' )e can see that Project ( has the shortest pabac3 time

hence Project ( is better

• #iscounted *aybac+ *eriod

%roject S

ear %ash Flo) Present ;alue

Factor = &-

&.i!n


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1 1/ /.,/, ,./, ,/.,10

2 6/ /.*26 ,.#6 1.$#0

$ */ /.9#1 6/./* 1*.9$

t )ill ta3e 2 ears an' 41.$# 5 6/./*0 127 8 *.26 months to pa bac3 )hich is 2 ears an'

, months )hen )e roun' up

n terms o! 'iscounte' pabac3 perio' metho' )e can see that Project ( has the shortest

pabac3 time hence Project ( is better

• N%/

%roject S


Factor=

&-&.i!

n


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/ 1//0 1 1//0 1//0

1 9/ /.*$$ #*.$1 1.6,0

2 #/ /.6, $.9 6.,,0

$ 2/ /.#9, 11.#9 .#*

=et Present ;alue 8 .#*

At 1/@ - =P; is 1,.,6 an' at 2/@ =P; is .#*.

Appling to ++ !ormula> ++ is 8 22.,9@

%roject ,


Factor = &-&.i!n there!ore higher the ++ lessen the ris3 o! the

project is an' there!ore Project ( is better.

• Modified "nternal rate of return

MIRR=n

√ FutureValue of cashflow

Initial Investment −1

%roject S

ear

/ 1 2 $

Projecte' cash !lo) -1// 9/ #/ 2/

ear 1 cash !lo) compoun'e' at 1/@ !or

t)o ears

*.9


t)o ears

##

Mo'i!ie' cash !lo) -1// 1#,.9

$


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M++ 83

√159.7

100−1=16.88

%roject ,

ear

/ 1 2 $

Projecte' cash !lo) -1// 1/ 6/ */


t)o ears

12.1


t)o ears

66

Mo'i!ie' cash !lo) -1// 1#*.1

M++ 83

√158.1

100−1=16.50

Project ( has the highest M++ hence project ( can be selecte' to enhance the outcome.


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%art 2 – ()aluation of techni0ues

%aybac+ *eriod

he pabac3 perio' measures the time perio' epecte' number o! months or ears0 it ta3es

to !ull cover the total cost o! the investment use'. Csual metho' in this is to subtract cash

!lo)s !rom the cost until the remain'er )ill be ero. his is usuall )hen companies have a

limit to pabac3 perio' !or all o! their investments.

Pabac3 perio' is eas an' can be calculate' "uic3l compare' to other metho's an' )ill

provi'e a li"ui'it measure o! the project. t )ill give a prominent to projects )hich have

higher cash !lo)s at the beginning than a!ter some more ears. his can be important !or a

smaller compan )ho have a smaller )or3ing capital ccle compare' to other companies.

Main 'ra)bac3s o! this metho's are that it ignores the time value o! mone an' also ignores

all cash !lo)s beon' the pabac3 perio'. A compan )ith a project that ecee's the

pre'etermine' value )ill not be ta3en into consi'eration an' these are not base' economic

!oun'ation at all. Pabac3 perio' also 'oesnDt consi'er ris3 'i!!erences> an' this metho'

calculate using the same )a !or both ris3ier an' sa!er projects. his metho' )ill ma3e a

compan bias to)ar's short-term investment an' ma3e it 'i!!icult !or companies to accept

long term investments.

#iscounted *aybac+ *eriod


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Net *resent )alue

=et present value is the 'i!!erence that )e ta3e !rom present value o! the cash !lo)s an'

investment 'one at the beginning o! the project. =P; is consi'ere' as a measure o! ho)

much value )ill be create' or a''e' i! a compan un'erta3es an' carr on b investing. n

calculating =P;> companies normall use eighte' Average %ost o! %apital A%%0 as the

'iscount rate in calculating present value o! each !lo). his )ill enable a compan to

'etermine the increase in )ealth as !or to'a )hich as a result !rom un'erta3ing a project an'

this )ill enable a management o! a compan to compare 'i!!erent projects )hich available at

once an' select the best to minimise the ris3 as )ell as to enhance the )ealth. Csuall projects )ith higher =P;s )ill be selecte' as projects )ith negative =P;s are consi'ere' as

a not goo' investment. ! there are multiple projects to be chosen> multiple projects )ith

highest outcome can be selecte'.

Main 'ra)bac3 o! =P; can be consi'ere' as it re"uires an estimation o! cost o! capital )hen

calculating the =P; o! a project. Another problem )ith =P; is that it is epresse' in mone

value but not in percentage terms to get a goo' i'ea about the investment vs. outcome.

"nternal rate of return

nternal rate o! return is the 'iscount rate )hich e"uates the investment amount to present

value o! !uture cash !lo)s. ?r in other )or's this is about the %ost o! %apital rate that gives

the ero value !or =P;. ++ is more popular because it can be easil compare' )ith %?%.

Also an ++ provi'es the !ollo)ings:

a1 Provi'es 'etails )hether it )ill increase a !irmDs value or notb1 hen calculating ++ it consi'ers all the cash !lo)s or the project such as in =P;.

c1 ime value o! mone is ta3en to consi'erations.

d1 Also consi'ers the ris3 o! !uture cash !lo)s b consi'ering cost o! capital in the

'ecision rule.

Main 'ra)bac3s o! ++ metho' can be consi'ere' as:

a. (uch as in =P; this metho' also re"uires an estimation o! the cost o! capital in

ma3ing a 'ecision )here )rong assumptions can lea' to !alse values.

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b. hen assess mutuall eclusive projects ++ might not give the proper value

maimiing 'ecision an' also )hen there is capital rationing.

c. ++ is not suitable in situations such as the sign o! the cash !lo)s o! a project change

more than once 'uring the projectDs li!e.

Mo'i!ie' internal rate o! return

Mo'i!ie' nternal rate o! return M++0 is more li3e ++ but in terms o! a theoretical

bac3groun' it is much superior )here it solves t)o main )ea3nesses o! ++. hese

)ea3nesses overcome in M++ metho' are it correctl assumes reinvestment at the projectDs

cost o! capital an' also avoi's the problem o! multiple ++s being use'. Even though M++

is not use' )i'el in practice in the societ this is consi'ere' as the best metho' to evaluate

projects. Follo)ing are clear a'vantages o! M++:

a. Provi'e 'etails about ho) much value o! the !irm )ill be increase' b the investment.

b. %onsi'ers all tpes o! cash !lo)s> time value o! mone> an' also the ris3iness o!

'i!!erent !uture cash !lo)s.

ith that !ollo)ing 'isa'vantages are also can be seen in M++:

a. As in some o! previous metho's in M++ also it re"uires an estimation o! cost o!

capital to ma3e a 'ecision.

b. Might not give the value-maimiing project )hen there are number o! mutuall

eclusive projects or )hen there is capital rationing b the compan.

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%art ' Multi*le Choice 3uestions and Short Ans4ers

&uestion Ans)er

&1 1&2 False

&$ 2

&

2

&6 $

&9 $

&* $

&, 1

&1/ 2

&11 2&12 $

&1$:

=on- sstematic ris3 speci!ic ris3'iversi!iable ris3resi'ual ris30 An uncertaint tpe that

comes )hen investing in a compan or in a certain in'ustr. his can be re'uce' mainl )ith

investing in 'i!!erent companies or in'ustries 'iversi!ication0.

(stematic ris3 mar3et ris3un-'iversi!iable ris30 this is a tpe o! ris3 that is inherent to the

)hole mar3et or )hole mar3et segment. his is also 3no)n as volatilit )hich is 'ue to 'a

to 'a !luctuation o! stoc3 prices.

&1 2

&1#

&16

&19 1

&1* 2

&1, $&2/ 1

*


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5eferences

Berr>A. 1,,,0> Financial Accounting An Introduction> (econ' E'ition> Gon'on: hompson

Blac3> H. 2//,0> Introduction to accounting and finance> (econ' e'ition> Esse: Pearson

E'ucation

Ho)thorpe>%. 2//#0> Financial Accounting for non-specialists> Gon'on :hompson

Gearning

Iotler> P.> Armstrong> H.> (aun'ers> J. an' ong> ;. 1,,,0> Principles of Marketing > 2n'

E'ition> %ambri'ge: Prentice Kall

Giner> +. (. an' Giner> /.G. 2//*0> Cash Flow Strategies> (an Francisco: John ile an'

sons

+?(( (> E(E+FEG< +> J?+

MBA-622 - Financial Management

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