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Tools for investment analysis
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The purpose of this paper is to explain the importance of net present value along with other investment criteria used in determining the value of business decisions regarding today’s investments for future returns. The paper will define what is meant by net present value and show how managers can use it as an analysis tool to decide if an investment is worth the calculated risk. Also, there will be three methods discussed that managers can use to propose the best financial projects to invest in to increase revenue for its owners. The methods discussed will include: the net present rule, the payback rule, and the internal rate of return. With each method there will be an explanation of their advantages and disadvantages for managers to consider in their analysis. In conclusion there will be a brief summary of important points regarding the benefits in calculating present values of cash assets toward investing for future corporate profits.
Every day in business corporations are making decisions about their products and services to make them better and cheaper while making a profit. In this day-to-day challenge many managers have to make financial decisions based with hopes of profitable returns for the future. There are some financial risks involved, but there are ways wherein those financial investment decisions can be based on calculations through net present value (NPV) and other investment criteria to minimize the element of risk. In these calculations rest tools for managers to better predict investment strategies for more profitable future valuations in their company’s success. These tools help managers determine what project is right for today and effects on future decisions made down the road while keeping in mind th...
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...he information needed in order to project true viable results for future profitability for the company’s owners.
Works Cited
(2011). Retrieved February 8, 2014, from Accounting Explanation: http://www.accountingexplanation.com/net_present_value_method.htm
Daniel, H. (2011, July 27). Retrieved February 8, 2014, from BenefitOf.net: http://benefitof.net/benefits-of-npv/
Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2011). Essentials of Coporate Finance (7th ed.). New York, New York, US: McGraw-Hill/Irwin. Retrieved January 19, 2014
Sisson, N. B. (2014). eHow. (Demand Media) Retrieved February 9, 2014, from ehow.com: http://www.ehow.com/about_7240895_definition-internal-rate-return-_irr_.html
Thomason, K. (2014). eHow. (I. Demand Media, Producer) Retrieved February 8, 2014, from http://www.ehow.com/info_8636982_advantages-present-value-project-selection.html
Star Appliance is looking to expand their product line and is considering three different projects: dishwashers, garbage disposals, and trash compactors. We want to determine which project would be worth doing by determining if they will add value to Star. Thus, the project(s) that will add the most value to Star Appliance will be worth pursuing. The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.
You would not buy a home, car or other large purchases without researching what product offered you the most for your money. The same is true when investing in a company. Investors do avid research on multiple companies to find what company matches the investors' criteria. In this paper Team C will research both AT&T and Verizon's financial documents. Team C will compare selected ratios, cash flow and make recommendations how both companies can manage cash flow for the future.
...eting tool that show the differences between the present value of revenues and the present value of expenses. The project can be profitable when the net present value is positive. In other words, the present value of revenues is greater than the present value of expenses. Profitability index is another tool for evaluating investment projects, which is the ratio of the PV of benefits on the PV of costs. A project can be beneficial if the profitability index is greater than 1. Also, it has the same idea as NPV that In other words, the present value of benefits is greater than the present value of costs. However, these two methods (NPV and Profitability Index) have been used to evaluate the proposal of implementing EHR.
Berk, J., & DeMarzo, P. (2011). Corporate finance: The core, second edition. (2nd ed.). Boston, MA: Prentice Hall.
This object is one of the financial goals to invest properly. Marriott used discounted cash flow techniques to evaluate potential investment. It is beneficial because it is considered present time value. Projects which increase shareholder value could be formed with benchmark hurdle rates, the company can ensure a return on projects which results in profitable and competitive advantage.
Merck's investment valuation Decision tree approach: This approach is suitable for projects that do not have to be funded all at once. The alternatives, probability of payoffs are identified using diagrams which are simple to understand and interpret with brief explanations giving important insights. It identifies managerial flexibility to reevaluate decisions using new information and then either invest additional funds or terminate the project. Results of the decision tree. This analysis shows that the project's NPV is $13.37 million.
Discounted cash flow is a valuation technique that discounts projected cash inflows and outflows to evaluate the potential value of an investment. There are three discounted cash flow methods: Net Present Value (NPV), Profitability Index (PI) and Internal Rate of Return (IRR). The net present value discounts all cash inflows and outflows at a minimum rate of return, which is usually the cost of capital. The profitability index refers to the ratio of the present value of cash inflow to the present value of cash outflows. The internal rate of return refers to the interest rate that discounts cash inflow projections to the present to ensure that the present value of cash inflows is equivalent to the present value of cash outflows (Brown, 1992).
When discussing the cost of equity capital, or the rate of return required by investors for their share expenses, there are three main models widely used for analyzation. These models are the dividend growth model, which operates on the variable of growth and future trends, the capital asset pricing model (CAPM), which operates on the premise that higher returns are a result of higher risk, and the arbitrage pricing theory (APT), which has a more flexible set of criteria than CAPM and takes advantage of mispriced securities
Net Present Value (NPV), Internal Rate of Return (IRR) and payback time for each cases have been calculated and the case with highest value for NPV and IRR and earliest payback time chosen as the most attractive option to be presented to senior managers. The best economic one was drilling 28 horizontal wells and utilising FPP while transporting oil with shuttle tanker and delivering produced gas via pipeline to available pipeline on Forties filed. This case resulted in NPV of 1,134 US$MM, IPR of 17.94% with payback time of 7 years.
Ross, S.A., Westerfield, R.W., Jaffe, J. and Jordan, B.D., 2008. Modern Financial Management: International Student Edition. 8th Edition. New York: McGraw-Hill Companies.
There is a range of criteria relevant for a decision of financing a new venture. To construct my list for the evaluation of a new company as an opportunity I have selected to refer to t...
William Sharpe, Gordon J. Alexander, Jeffrey W Bailey. Investments. Prentice Hall; 6 edition, October 20, 1998
Brealey, Richard A., Marcus, Alan J., Myers, Stewart C. 1999, Fundamentals of Corporate Finance, 2nd edn, Craig S. Beytien, USA.
When compared to the physical capital maintenance concept, the financial capital maintenance concept is the better choice for standard setting when distinguishing between a return of capital and a return on capital. The main argument in favor of physical capital maintenance is that it provides information that has better predictive value, confirmatory value, and is more complete. However, due to agency theory, prospect theory, and positive accounting theory, neutrality and completeness under physical capital maintenance would be impaired so gravely that predictive value and confirmatory value become inefficacious. As a result, financial capital maintenance, with its use of historical cost, is able to provide information to decision makers with stronger confirmatory value and predictive value.
Explain why in practise other methods of evaluating investment projects have proved to be more popular with decision-makers than the net present value method. (Please compare at least three (3) methods)