The Investment Detective Essay Example

do.

By analyzing just the cash flows, you are not taking into account the time/value of money. A dollar earned today is not worth the same as a dollar earned in the future, 1, 5, or 15 years down the road. If you want to compare cash flows, then you must bring all cash flows to the present. This is done by taking into account the time/value of money.

2. What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why?

a. The most commonly used, and arguably best quantitative ranking methods, are the NPV and IRR.

The NPV is dominant because it’s straightforward, it factors in the risk level of the project, takes into account all cash flows, considers the time/value of money, and it shows the total wealth change. The IRR is good too because it compares with cost as a benchmark, it also considers time/value of money, takes into account all cash flows, and lastly it’s a percentage measurement. Other quantitative ranking methods are shown below in greater detail.

3. What is the ranking you found by using quantitative methods? Does this ranking differ from the ranking obtained by simple inspection of the cash flows?

a. Yes, the rankings differ from the ranking obtained by simply inspecting only the cash flows. The reason being that by inspecting only the cash flows, you neglect to take into account the time/value of money, the risk of the project, and it does use any benchmarks to evaluate success. See below for calculations and graphs of the other quantitative methods used.

4. What kinds of real investment projects have cash flows similar to those in the exhibit 1?

a.

Project 1 is most like a bond that is selling with an extremely high par value, payments are made periodically and at the end to get the principle.

b. Projects 2 and 7 are most like a company that is buying equipment. As the equipment gets older the output starts to decrease as well as cash flows coming in. As new technology becomes available another investment will need to take place.

c. Project 3 would be similar to a 15 year CD with a very high return.

d. Project 4 would be similar to a company that goes into a certain area, makes changes, takes their profit, then at the end of the project, they need to rebuild what they changed and return it to its original form. This would explain the cash flows coming steadily in, then in the last year, a large lump sum taken out.

e. Project 5 is most similar to an annuity that gives a set amount of money for the life of the investment.

f. Project 6 is similar to a T-bill.

g. Project 8 is most like a pharmaceutical or aerospace company that spends money in the beginning years on R&D costs, then makes that money back throughout the life of the project as profits increase year after year.

Calculations

1) NPV Rank: Cash Flows Only 1. Project 3 2.

Project 5 3. Project 8 4. Project 4 |WACC |NPV | | |PROJECT 1 | | |PROJECT 1 | | |PROJECT 1 | |PROJECT 1 |PROJECT 2 |PROJECT 3 |PROJECT 4 |PROJECT 5 |PROJECT 6 |PROJECT 7 |PROJECT 8 | |10% |7. 4 |- |14. 835 |9. 09 |13. 14 |1 |2. 73 |6. 839 | |11%

|- |- |14. 955 |9. 66 |14. 76 |- |2. 855 |6. 951 | |12% |- |- |- |10. 59 |- |- |2. 985 |- | |13% |- |- |- |12. 165 |- |- |3. 455 |- | |14% |- |- |- |13. 245 |- |- |3. 98 |- | |15% |- |- |- |14. 7 |- |- |4. 78 |- | | [pic] Rank: Discounted Payback @ 10% WACC 1. Project 6 2. Project 7 3. Project 1 4. Project 4 *Project 8 has a shorter discounted payback than project 1 and project 4, but projects 8 and 7 are mutually exclusive so we cannot accept both.

Project 7 has a shorter discounted payback than project 8, thus it is accepted and project 8 is rejected. Rank: Discounted Payback @ 11% WACC 1. Project 7 2. Project 4 3. Project 5 4. Project 3 *Project 8 has a shorter discounted payback than projects 4,5,and 3, but projects 8 and 7 are mutually exclusive so we cannot accept both. Project 7 has a shorter discounted payback than project 8, thus it is accepted and project 8 is rejected. Rank: Discounted Payback @ 12% WACC 1. Project 7 2. Project 4 *The rest do not have a discounted payback at 12% or above.