Compare the results of the three (3) methods by quality of information for decision making, business and finance assignment help

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Compare

the results of the three (3) methods by quality of information for

decision making. Using what you have learned about the three (3)

methods, identify the best project by the criteria of long term increase

in value. (You do not need to do further research.) Convey your

understanding of the Time Value of Money principles used or not used in

the three (3) methods. Review the video titled “NPV, IRR, MIRR for Mac

and PC Excel” (located at https://www.youtube.com/watch?v=C7CryVgFbBc and previously listed in Week 4) to help you understand the foundational concepts:

Scenario Information:
Assume

that two gas stations are for sale with the following cash flows; CF1

is the Cash Flow in the first year, and CF2 is the Cash Flow in the

second year. This is the time line and data used in calculating the

Payback Period, Net Present Value, and Internal Rate of Return. The

calculations are done for you. Your task is to select the best project

and explain your decision. The methods are presented and the decision

each indicates is given below.

Investment Sales Price CF1 CF2
Gas Station A $50,000 $0 $100,000
Gas Station B $50,000 $50,000 $25,000

Three (3) Capital Budgeting Methods are presented:

  1. Payback Period: Gas Station A is paid back in 2
    years; CF1 in year 1, and CF2 in year 2. Gas Station B is paid back in
    one (1) year. According to the payback period, when given the choice
    between two mutually exclusive projects, the investment paid back in the
    shortest time is selected.
  2. Net Present Value: Consider the gas station example above under the NPV method, and a discount rate of 10%:
    NPVgas station A = $100,000/(1+.10)2 – $50,000 = $32,644
    NPVgas station B = $50,000/(1+.10) + $25,000/(1+.10)2 – $50,000 = $16,115
  3. Internal Rate of Return: Assuming 10% is the cost of funds; the IRR for Station A is 41.421%.; for Station B, 36.602.

Summary of the Three (3) Methods:

  • Gas Station B should be selected, as the investment is returned in 1 period rather than 2 periods required for Gas Station A.
  • Under the NPV criteria, however, the decision favors gas station A,
    as it has the higher net present value. NPV is a measure of the value of
    the investment.
  • The IRR method favors Gas Station A. as it has a higher return, exceeding the cost of funds (10%) by the highest return.

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