The investment Detective
Answer Q1:
We can rank the projects by simply inspecting the cash flows (mention bellow), yet it’s not a good measure to rank them.
We can’t rank the projects by only simple inspection of the cash flows because of the time value of money and cost of capital of companies. We use capital budgeting tools to measure financial performance of projects.
The Ranking by simply inspecting the cash flows:
| Rank | 1st | 2nd | 3rd | 4th | 5th | 6th | 7th | 8th |
| Projects | 3 | 5 | 8 | 4 | 1 | 7 | 6 | 2 |
| Cash Flows | $10,000 | $4,200 | $4,150 | $3,561 | $3,310 | $2,560 | $2,200 | $2,165 |
Answer Q2:
In order to rank these projects, in a purely quantitative manner, we used the following for the 8 projects:
- Net Present Value (NPV)
- Internal Rate of Return (IRR)
- Payback Period (PP)
- Profitability Index (PI)
- Net Present Value (NPV)
| Year | Project 1 | Project 2 | Project 3 | Project 4 | Project 5 | Project 6 | Project 7 | Project 8 |
| 0 | ($2,000) | ($2,000) | ($2,000) | ($2,000) | ($2,000) | ($2,000) | ($2,000) | ($2,000) |
| 1 | 300.00 | 1,514.55 | – | 145.45 | 254.55 | 2,000.00 | 1,090.91 | (318.18 ) |
| 2 | 272.73 | 276.03 | – | 165.29 | 231.40 | – | 743.80 | (49.59) |
| 3 | 247.93 | 123.97 | – | 262.96 | 210.37 | – | 225.39 | 45.08 |
| 4 | 225.39 | – | – | 269.79 | 191.24 | – | 61.47 | 239.05 |
| 5 | 204.90 | – | – | 268.24 | 173.86 | – | 43.46 | 434.64 |
| 6 | 186.28 | – | – | 248.37 | 158.05 | – | – | 677.37 |
| 7 | 169.34 | – | – | 226.82 | 143.68 | – | – | 1,154.61 |
| 8 | 466.51 | – | – | 207.13 | 130.62 | – | – | – |
| 9 | – | – | – | 189.15 | 118.75 | – | – | – |
| 10 | – | – | – | 172.72 | 107.95 | – | – | – |
| 11 | – | – | – | 157.72 | 98.14 | – | – | – |
| 12 | – | – | – | 143.70 | 89.22 | – | – | – |
| 13 | – | – | – | 130.64 | 81.11 | – | – | – |
| 14 | – | – | – | 119.03 | 73.73 | – | – | – |
| 15 | – | – | – | – | 67.03 | – | – | – |
| S PV(CF) | 2,073.086 | 1,914.545 | 2,393.920 | 2,228.222 | 2,129.702 | 2,000 | 2,165.041 | 2,182.984 |
| NPV | 73.086 | (85.455) | 393.920 | 228.222 | 129.702 | 0 | 165.041 | 182.984 |
| Rank | 6th | 8th | 1st | 2nd | 5th | 7th | 4th | 3rd |
- Internal Rate of Return (IRR)
| Projects | Project 1 | Project 2 | Project 3 | Project 4 | Project 5 | Project 6 | Project 7 | Project 8 |
| IRR | 10.87% | 6.31% | 11.33% | 12.33% | 11.12% | 10.00% | 15.26% | 11.41% |
| Rank | 6th | 8th | 4th | 2nd | 5th | 7th | 1st | 3rd |
All of these projects are accepted except Project 2 because its cost of capital has higher percentage than the percentage project internal rate of return. Moreover, Project 6 will be a subject of be in different because the cost of capital equal to internal rate of return, which lead to break even project.
- Payback Period (PP)
In Payback Period there are two method, non-discounted cash flow and discounted cash flow. Drawback of non-discounted cash flow does not consider TVM and the rate of return, and the discounted cash flow does not examine all the cash flows.
| Projects | Project 1 | Project 2 | Project 3 | Project 4 | Project 5 | Project 6 | Project 7 | Project 8 |
| Payback Year | 7 | 2 | 15 | 6 | 8 | 1 | 2 | 7 |
| Payback | 2,310 | 2,000 | 10,000 | 1,977 | 2,240 | 2,200 | 2,100 | 4,150 |
| Discounted Payback | 1,606.58 | 1,790.58 | 2,393.92 | 1,360.10 | 1,493.78 | 2,000 | 1,834.71 | 2,182.98 |
| Decision (DPP) | Reject | Reject | Accept | Reject | Reject | Be in different | Reject | Accept |
| Rank | 6th | 5th | 1st | 8th | 7th | 3rd | 4th | 2nd |
- Profitability Index (PI)
| Projects | Project 1 | Project 2 | Project 3 | Project 4 | Project 5 | Project 6 | Project 7 | Project 8 |
| PI | 1.037 | 0.957 | 1.197 | 1.092 | 1.065 | 1.000 | 1.083 | 1.0773 |
| Rank | 6th | 8th | 1st | 2nd | 5th | 7th | 3rd | 4th |
All the projects will be undertaken except for project 8 since it is mutually exclusive with project 7, and project 6 and 2 will not be undertaken since they have IRR that is less than the 10%, the discount rate. Project 1 also might not be taken since “certain officers of the company have recently asserted that the discount rate should be much higher.”
| Rank | 1st | 2nd |
| Project | 8 | 7 |
| IRR | 11.41% | 15.26% |
| NPV | 182.98 | 165.04 |
Since these two projects are mutually exclusive and have the IRR above 10%, Project 8 will be chosen because it has higher NPV.
| Rank | 1st | 2nd | 3rd | 4th | 5th | 6th | 7th | 8th |
| Project | 3 | 4 | 8 | 7 | 5 | 1 | 6 | 2 |
| PI | 1.197 | 1.092 | 1.083 | 1.0773 | 1.065 | 1.037 | 1.000 | 0.957 |
All the projects will be undertaken except for project 7 since it is mutually exclusive with project 8, and project 6 and 2 will not be undertaken since they have PI’s equal to 1 and 0.957, because they are not greater than 1.
Selected Projects as per the quantitative methods as follow:
| Rank | 1st | 2nd | 3rd | 4th |
| Projects | Projects 3 | Projects 4 | Projects 8 | Projects 5 |
- Comparing the quantitative methods, we noticed that project 3 scored 1st four times using simple inspections of cash flows, NPV, PP, and PI. Project 7 however, scored 1st only through using the IRR method. Looking on the last ranked projects, project 2 has scored last 4 times using simple inspections of cash flows, NPV, IRR, and PI.
- Net Present Value is considered the best approach since it:
- Uses Cash Flows.
- Uses all the Cash Flows of the project.
iii. And discounts the Cash Flows properly.
And through using the NPV approach, Project 3 got the highest NPV, 393.92, and then comes 4, 8, 5 and 1.
Answer 3:
Selected Projects as per the quantitative methods as follow:
| Rank | 1st | 2nd | 3rd | 4th |
| Projects | Projects 3 | Projects 4 | Projects 8 | Projects 5 |
The above table showing that it is absolutely the rank will be differ from the ranking obtain by simple inception of the cash flow
Answer 4:
Project 1 Bonds
Project 2 Equipment Depreciation
Project 3 Land or real assets investments
Project 4 Diary factory that incur agricultural costs
Project 5 Car Loan
Project 6 Stock
Project 7 Trucks Depreciation
Project 8 Construction projects
