UNIVERSITY OF GLOUCESTERSHIRE

SCHOOL OF BUSINESS AND LAW

MFP/MBA

MODULE: Account Decision Management

Techniques
NAME: Nikunj Patel
STUDENT NUMBER: 0661SWSW1109
INTAKE: Nov 09
EMAIL: nikunjrpatel1986@yahoo.co.in

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 PROJECT
CONTAIN………………

1. Introduction....................................................................... 3

2. Background of the study.................................................... 3

3. Net Present Value..............................................................3

4. Internal Rate Of Return................................................5

5. Project Sum......................................................................6

6. Conclusion.......................................................................... 9

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 7. References and Bibliography............................................. 10

INTRODUCTION
Successful organization needs to capital investment and strategic changes in the business. The
investment decision is the decision to commit the firms and other resources to a particular course
of action. The need to commit funds by real investment such as building and equipments and
financial investments and also such investment in share and other securities. Investment
appraisal should add value to business organization. In the when preparing capital budgeting also
forecasting the investment needs. And indentifying the company project and find out its needs
and fulfill its. Investment appraisal selecting the best alternatives and making the expenditure
and monitoring whole project of the company. Basically both type of investment helpful for
former category. Usually referred to as capital investment. The number of alternative techniques
to the Net present value and internal rate of return the both are techniques. Investment appraisal
to consider their strengths and limitations managers in the business usually point of view profit
and measure of perfomance.it might be assumed capital project appraisal should seek to assess
whether the investment is expected to be “profitable” or not. in the business decision making can
be denoted by incremental activity. Business generally going concerns with fairly clear strategies
and well established management processes.

BACKGROUND OF STUDY
Discounted cash flow analysis is family of techniques of which is NPV and IRR and the
profitability index approach.

• NET PRESENT VALUE

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 We have assumed that the paramount objective of the firm is to create as much wealth as
possible for its owner through the efficient use of existing and future resources. Most
important NPV advantage is, in addition to maximization of shareholders wealth, there is
direct link between NPV and the share prices. Under the NPV method makes assumptions
which are that:

• There is single market rate of interest for both borrowing and lending

• An individual can borrow or lend any amount of money at the rate.

• There are no transaction costs or taxes.

• Investors are rational, that is they prefer more money to less and want to maximize their
wealth.

To measure its worth, we need to consider the value of the current and future benefits less
costs arising from the investment. The net present value method is applied to evaluate the
desirability of investment opportunities.NPV is determined by summing the net annual cash
flows, discounted at a rate that cost of an investment of equivalent risk on the capital market.
Wealth is maximised by accepting all projects that offer positive net present values when
discounted at the required rate of return for each investment.

Goal Increase shareholder value

Inputs Annual Cash Flow Cost of Capital

(Xt) (K)

Financial analysis Discount cash flow at the cost of capital to find

net present value

NPV signal + _

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Decision outcome
ACCEP REJEC
T

• Managers are assumed to act in the best interest of the owners or shareholders when the
market rate of exchange between current rates of interest.

• Managers should undertake all projects up to the point at which marginal return on the
investment is equal to rate of interest on equivalent financial investment on capital
market.

• Management need to concern with shareholders take a particular time to make

consumption or risk preference. Well managing capital market, shareholders can borrow
lend funds to achieve their personal requirements and also risky and safe investment.
They can achieve the desired risk for those consumption requirements.

INTERNAL RATE OF RETURN

The NPV depends upon discount future flow of cash to express them at their present value. It is
based to on some unrealistic assumptions about the market but is easier to apply than the internal
rate of return.IRR calculate the correct return, or yield, requires us to find the rate that equates
the present value of future benefits to the initial cash outflow. The IRR is that discount rate, r,
which, when applied to project cash flows(xt),produces a net present value of zero. Where the
IRR exceeds the required rate of return (r>k), the project should be accepted.

Suppose a saving scheme offers a plan whereby, for an initial investment of £100, we would
receive £112 at the year end. The IRR is thus 12%

£100 (1 + r) =£112

= 12%

If another project offered a single payment of £148 in 3 years time, from an initial investment
of £100,the IRR is found by solving:

£100 (1 +r)3 =£148

Turning to the present value interest factor (PVIF) table for three years and we got nearest to
0.6757.we find that the IRR for the investment is about 14 %.

The imperfect markets, the capital budgeting problem may involve the allocation of scarce

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resources among competing, economically desirable projects, not all of which can be undertaken.
This capital rationing applies equally to non-capital, as well as capital, constraints.

HARD RATIONING

Capital rationing may arise either because a firm cannot obtain funds at market rates of return, or
because of internal imposed financial constrains by management. External imposed constraints
are referred to as hard rationing and internally imposed constraints as soft rationing.

• The problem of law investments essentially derives not from a shortage of

finance but from an inadequate demand for funds.

• Capital constrains, where they exist, tend to be internally imposed rather than
externally imposed by the capital market.

• Capital constraints are more actually experienced by smaller, less profitable

and higher-risk firms.

SOFT RATIONING

Why should the internal management of a company wish to impose a capital expenditure
constraint that may actually result in the sacrifice of wealth-creating projects? Soft rationing may
arise because of the following:

• Management sets maximum limits on borrowing and is unable or unwilling to

raise additional equity capital in the short term. Investment is restricted to
internally generated funds.

• Management pursues a policy of stable growth rather than a fluctuating growth

pattern with its attendant problems.

• Management imposes divisional ceilings by way of annual capital budgets.

Many times in business capital rationing characteristic to those problem. Company resources
have to be allocated between competing alternatives. And decision making is seeking to attain.
And constraints, in one form or another, imposed on the decision-maker.

ANS:2

Project 1> ANS :( A) ANS :(B)

ANCF=1, 00,000 501900/449400=52500

Disc Factor @15%=5.019 419200/449400=30200

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 Disc factor @20%=4.192 NPV :( ANCF*PV)-Initial investment

P.V@15%=501900 (1, 00,000*14%)-449400

P.V @20%=419200 (1, 00,000 *5.216)-449400

IRR=15% +52500/52500+30200 (20-15) NPV=£72,200

= 15%+52500/82700 *5%

=15%0.635*5%

= 15% +3.17%

= 18.17%

Project>2 ANS :( C) ANS:(D)

If IRR is 20% then NPV=0 NPV= (ANCF*PVF)-Initial investment

NPV=(ANCF*PVF)-Initial investment = (70,000*5.216)-2,93,440

0=(70,000*4.192)-initial investment = 3,65,120-2,93,440

Initial investment=£2, 93,440 NPV=£71,680

Project>3 ANS (E) ANS :( F)

If IRR=14%then NPV=0 NPV= (ANCF*PVF)-Initial investment

NPV-(ANCF*PVF)-Initial investment 35624=(38344*PVF)-2,00,000

0= (ANCF*14%) -2, 00,000 35624=2, 00,000= (38344*PVF)

2, 00,000= (ANCF*5.216) 2, 35,624=38,344*PVF

2, 00,000/5.216=ANCF PVF=2, 35,624/38,344

ANCF=£ 38,344 PVF=6.145

We can see that 6.145 in company table at the rate 10% cost of capital

Project>4 ANS :( G)

NPV=PV of ANCF –Initial investment

39000=PV of ANCF-3, 00,000

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3, 39,000= PV ANCF

PV ANCF=ANCF*Cost of capital

3, 39,000=ANCF*5.650

3, 39,000/5.5650=ANCF

ANCF=£60,000

ANS: (H)

ANCF=60,000

DIS@14%=5.216

DIS@16%=4.833

P.V@14%=3,12,960-Initial investment

=3, 12,960-3, 00,000

=12,960

P.V@16%=2,89,980-Initial investment

=2, 89,980-3, 00,000

= -10,020

IRR=14%+12,960/12,960+10,020 (16-14)

=14% +0.564 (2%)

=14 % +1.128

=14 % +1.128

IRR=15.128%

ANS (B):

Project 2 is best for the AP ltd.because of annual cash flow £70,000 and initial investment
£2, 93, 440,if IRR 20% than we take NPV=0 than we can apply NPV=(ANCF*PVF)-Initial
investment . The net present value AP ltd is found by multiplying the annual cash flow by the
present value interest factor than an immediate cash outlay is not discounted as it is already
expressed in present value terms.

AP LTD in project 2 offers a positive NPV of £71,680 and would increase shareholders wealth

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given that the proposals are mutually exclusive so project 2 should be accepted.

What does an expected NPV of £ 71,680 from the project 2 proposals really mean? The projects
future cash flow are sufficient for the firm to pay all costs associated with financing the project
and to provide an adequate return to shareholders. And also proposal create wealth of £71,680
and the shareholders are that much better off than they were prior decision.

CONCLUSIONS:
In conclusion we can say that of the investment appraisal techniques, in the DCF method mostly
preferable to either pay back or ARR because it both takes account of the time value of
money.DCF method often create an illusion of exactness that the underlying assumptions do not
warrant. Managers cannot afford to treat investment decisions in a vacuum, ignoring the problem
of the business environment. Maximize shareholders wealth, use another DCF method NPV and
IRR because of it is easier to use, especially where there is a choice of projects and also a
fundamental assumption underlying DCF method is that decision makers pursue the primary goal
of maximising shareholders wealth. But many times in the business using DCF method some
common errors comes up. Neglect of working capital movements and failure to include scrap
values and also including interest charges in the cash flow.NPV is measure a wealth, while IRR
is a measure of return, and The problem with IRR is a measure of return, and the problem with
IRR is the idea that funds can be invested at the, often high rate of return generated by
calculations.

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REFERENCES AND BIBLIOGRAPHY
1. Horngren c.T, Harrison w T, Bamber LS, Best PJ , frager D J and Willett R,
Accounting, Prentiee-hall

2. Pike R H (1983) a review of recent trends in formal capital budgeting processes; accounting
and business research, summer pp201-8

3. Scarlett R. (1995) further aspects of the impact of taxation on the ability of investment,
management accounting, may p 54

4. Pike, R H (1992) “capital budgeting survey” an update Bradford university discussion paper,
in pike, R. H and Neale, C W (1993) corporate finance and investment prentice Hall
international.

5.”Corporate finance and investment” fifth edition companion website at

www.pearsoned.co.uk/pikeneale

6. Wood F , Business Accounting, F T prentice hall

7. Dyson J R, Accounting for none accounting Student, Student F T prentice hall.

8. http://www.valuebasedmanagement.net/methods_dcf.html

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9. http://moneyterms.co.uk/npv/

10. http://www.visitask.com/internal-rate-of-return.asp

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