FUNDAMENTALS OF FINANCE Essay Example | Topics and Well Written Essays - 2000 words

FUNDAMENTALS OF FINANCE - Essay Example So, going by the NPV rule projects B and C are the ones that SKATE plc should consider investing in. However, since project C is expected to generate much greater present value for the firm, it is the one that should be invested in if the firm is under the obligation to choose only one from the given set of three alternatives. The IRR rule says invest in a project only if the IRR is greater than the required rate of return. So in the given situation we have to calculate the IRRs for the three projects and compare those to the given required rate of return, 15%. So we find that the IRR to be lesser than the required rate of return in case of project A and greater for project B and C implying that only these latter two should be considered for investment. And the fact that the IRR is so high in case of project C implies that it is the project that should be chosen if only one has to be chosen. So we find similar results and suggestions for both the NPV and the IRR criteria. The discounted payback rule is another criterion for investment projects. Essentially this measure discounts the future cash flows obtainable from a certain project to calculate the time the project takes to payback the initial investment and hence the name. If for instance, X is the amount that needs to be initially invested, this rule solves for that value of T which satisfies the equation Where Ct represents the cash flow at time t and r is the discount rate representing the time value of money. If the value of T is lower than some predetermined time period, the project should be accepted according to this rule. So, with the cut off period being one year, project B should be accepted according to the discounted payback rule as the project generates cash flows the discounted values of which are greater than the initial investment in the first period itself. Similarly, for project C, we get C1/ (1.15) = 78.2609 > 50 = C0 implying that this project also pays back he invested