Please answer this and explain as much as possible. thank you Chapter 13 continu
ID: 2738847 • Letter: P
Question
Please answer this and explain as much as possible. thank you
Chapter 13 continues the theme introduced in Chapter 12 decision making. In this chapter we discuss making decisions about projects that have long-term implications specifically Capital Budgeting decisions. The methods we use to solve these types of problems are the Net Present Value (NPV method & the Internal Rate of return (IRR) method. Both methods involve discounting cash flows. Discounting means determining the Present Value of a future cash flow Present Value was introduced in Financial Accounting. If you need a little bit of a refresher review the appendix to this chapter. I also have a separate video file reviewing Present Value PLEASE NOTE that there is a lot of information in this chapter that we do not cover so make sure to read the introduction page in the learning module and the test review to find out the extent of what you need to study. There are two types of capital budgeting decisions screening decisions & preference decisions 1) What is the difference between the two types of decisions? 2) Can we use both the NPV method and the IRR method to solve both types? 3) Why do we decide to do a project if the NPV of the project works out to be zero or a positive number? What does it mean when the NPV works out to be a negative number?Explanation / Answer
1) A screening capital budget decision is a decision taken to determine if a proposed investment meets certain preset requirements, such as those in a cost/benefit analysis.
In a preference capital budgeting decision, the company compares several alternative projects that have met their screening criteria -- whether a minimum rate of return or some other measure of usefulness -- and ranks them in order of desirability. The decision makers then choose the investment or course of action that best meets company goals.
2) The screening decision is mostly made using the Net present value method and IRR is used for giving ranking to projects on preferential decisions.
Although both the methods NPV and IRR can be used for both types of projects f the decision is to be made regarding a few investment proposals but in case the proposed investments are high in number then IRR is used.
3) NPV is the present value of the project of all the future cashflows expected from it over its lifetime reduced by the initial cost of investment, so if this number comes zero it means that the project is at break-even and if the NPV is positive it means that the project will yield profits.
If the NPV comes out to be a negative number then it means that the project will not be able to meet is cost.