28 Jun NET CASH FLOW
Net cash flow
1. Net cash flow for the second year is $393,750.
Impact of depreciation on net cash flow
Depreciation expense increases the net cash flow value in an income statement as it provides a tax shield. Without depreciation, the net cash flow decreases, as there is no tax shield benefit. However, entrepreneur D net cash flow with depreciation expense for the second year was ($66,250), but with no depreciation expense, the net cash flow rose to $ 393,750.
2. Entrepreneur Ds NPV is $(447,056).
Recommendation
Entrepreneur D should stop investing in the business. To stop investing is the appropriate action as the NPV value in this project is less than zero. This implies that the entrepreneur will make losses from this investment.
3. Entrepreneur Ds IRR Value is -9%
Recommendation
Entrepreneur D should stop investing in the business. IRR value equates entrepreneur Ds NPV to zero. Entrepreneur Ds decision to stop investing is an appropriate decision as the IRR value is less than the weighted cost of capital in this project.
4. The accounting rate of return is different from the internal rate of return in this project as with the same capital investment the following accounting principles hold. The accounting rate of return is not a true value of return as it is based on average figures from the balance shed and income statement. On the other hand, the IRR is an alternative for the NPV method. Both techniques are true values as they depend on discounted cash flows in a project. Therefore, the two accounting ratios are different as ARR is based on profit while IRR is based on the present value of cash flows. In addition, ARR does not consider the time value of money, but IRR considers it.
5. The significance of unadjusted Payback period in this projects helps in determining that the payback period is within the life of the project otherwise if the project had positive returns, within the 8-year project life, and the NPV would be negative. Unadjusted payback period is not appropriate be in determining the acceptance or rejection of a project as it does not consider the time value of money. In addition, it ignores the cash flow generated after the payback period over the estimated project life.
6. Weighted average cost of capital is used in capital budgeting analysis using the NPV method, as it is the discount rate that discounts all cash flows in a project life (Lurin, 2010, p. 120).
7. Weighted average cost of capital is used in capital budgeting analysis using the IRR method. This is because the IRR is compared with weighted average cost of capital to determine whether a project should be undertaken or not. To accept a project, the IRR should be more than the weighted average cost of capital (Waxman, 2012, p. 163). On the other hand, a project is rejected if IRR is less than weighted average cost of capital.
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