Investment Detective

Investment Detective

1. Can we rank the project simply by inspecting the cash flows ??

Ans :  No. We cannot rank the project simply by inspecting the cash flows. This is because it ignores the Time value of Money and the opportunity cost of capital. The capital budgeting decision should be made by making use of different criteria like NPV, IRR, Profitability index, Payback & Discounted Payback period and Accounting rate of return. By using these tools it can be concluded if the sum of the cash flows of a project exceeds expected return rate or cost of capital of a company . The company decides to make an investment into the project only if the project is deemed to be profitable down the line. Because most of the cash flows are estimated in most of the projects, quality of estimation is another factor to be considered besides numerical capital budgeting tool.

1. What Criteria might you use to rank the project??  Which Quantitative rankings methods are better?? why??

Ans :  The Capital Budgeting criteria that can be used to rank the project are NPV, IRR, Profitability index, Payback & Discounted Payback period and Accounting rate of return.

Out of the available criteria, NPV & IRR can be used to make the investment decisions as they are the better tools available. In case of independent projects, both NPV & IRR can be used to make out the decision, whereas in case of mutually exclusive project NPV stands out, as it is the superior criterion compared to IRR. This is because IRR does not consider the realistic reinvestment assumption.

Apart from these criteria, others like Profitability index, Payback & Discounted Payback period and MIRR can also be used to supplement the decision carved out using NPV & IRR.

Q3 : What is the ranking you found using quantitative methods ?? Does this ranking differ from the one obtained by simple inspection of the cash flows ??

Ans: