Activity 9 Finanace _anh Giang

7/23/2019 Activity 9 Finanace _anh Giang

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ACTIVITY 9: NPV, IRR, ROI, payback period and ARR

1. Why is he !1,""" yo# recei$e oday %orh &ore han !1,""" yo# recei$e ne' year(

Wha concep does his i))#srae( Why is his concep paric#)ar)y i&poran %hen*ir&s e$a)#ae capia) b#d+ein+ proposa)s(

ANW-R

$1,000 we receive today worth more than $1,000 we receive next year or we also call a dollar

today is worth more than a dollar tomorrow is meaningful in a concept of time value of money

(TVM) !ccording to Moyer, Charles, William Kretlow, and James McGuigan (2011), the present

value ("V) is always less than or e#ual to the future value (V) %ecause money has interest&

earning potential The "V is the value of future cash flow in today's purchasing power, which is

descri%ed in a formula "V¿ C

(1+i)t

hile

* *ash payment

i + inflation rate

t + time

or example, we have $1,000, inflation rate estimating is -, so what will we receive after .

years/

"V $1,000

!fter 1 year $1,000 (100)21 + $341 5 $1,000

!fter . years $1,000 (100)2. + $36 5 $1,000

Therefore, we can see that the amount of money we receive %y following years is smaller than

the first year This concept is particularly important when firms evaluate capital %udgeting

proposals %ecause of a%ove theory and calculation 7f the firm has wrong evaluation in capital

%udgeting proposals, it can ma8e a lot of loss 9owever 7f the firm has exactly evaluation in

capital %udgeting proposals, the company can get many profits



. Wha is he ne presen $a)#e /NPV0 o* a )on+er& in$es&en pro2ec( 3escribe ho%

&ana+ers #se NPVs %hen e$a)#ain+ capia) b#d+e proposa)s.

ANW-R

:et present value (:"V) is a calculation that compares the amount invested today to the present

value of the future cash receipts from the investment :"V ta8es into account the si;e of the cash

inflows, %ut also ma8es ad<ustment for the timing of the money !ccording to =a8er and "owell

(.00>, p .0), :"V is ?the amount of cash flow in present value terms that the pro<ect generates

after repaying the invested capital and paying the re#uired rate of return on that capital@

This is one of the most popularly used in investment decision and the formula is descri%ed as

NPV =

[ R

1

(1+i)1+ R(1+ i)2 R

3

(1+i)3 +…

]& 7nitial cost

here ?i@ is rate of return per period

?A@ is net cash flow per period

The pro<ect manager will initially ta8e :"V into consideration when choosing investment

appraisal methods 9e wants to 8now how much the pro<ect earns %ac8 from the invested capital

and how long the return covers the investment 7t is difficult to understand the calculation and

estimate the value of inflow and outflow throughout the pro<ect's life atson and 9ead (.010, p1B3) point out the difficulty in estimating the cost of capital of company and selecting discount

rate is not straightforward and fixed during pro<ect life The pro<ect manager must 8now that the

assumption of :"V is availa%le in perfect mar8et competition inally, he also must assess the

ris8 of the pro<ect whether it can impact on the company's profit or not



4. As co&ponens in he ROI ca)c#)aion, %ha are &ar+in and #rno$er( Wha are he

hree bene*is o* ROI( -'p)ain ho% each bene*i can )ead o i&pro$ed pro*iabi)iy.

ANW-R

AC7 is a ma<or techni#ue to measure how much profits of investment center made compared

with the original amount invested

5or&#)a AC7¿

Earningsbefor interest ∧taxes ( EBIT ) Net investment ∈assets ( Assets employed)

x 100-

Cr AC7¿

EBIT

Salesrevenue x Salesrevenue

Assetemployed x

100-

+ "rofit margin (-) x !sset Turnover

here

"rofit margin (-) + EBIT

Sales revenue x

100-

!sset Turnover (times) +

Sales revenue

Asset employed

The %enefits of AC7 will %e as follows

irst of all, many managers will %e more concerned with current financial performance instead of

long term and AC7 is one of the metrics which managers want to increase most for maintaining

their position 7n order to 8eep high AC7, managers will slow down to replace assets or invest

new assets

Decondly, managers are encouraged to use AC7 for short&term decisions or instance, AC7 in

new pro<ects is always low in the first years %ecause these pro<ects will ta8e more time to get

high returns Do, the divisional managers will not invest into such pro<ects in the short run until

they have a high AC7



inally, the managers really want to improve AC7 to attract more investments of shareholders %ut

all methods are encouraged to use AC7 in short period of time %ecause they all affect the

company's long&term performance

6. -as 7#))e 7an#*ac#rin+

a. A$era+e operain+ asses

!verage operating asset + 100- x Eoperating asset .0F0 G operating asset .0F1H operating

asset .0F0

+ 100- x EI6B0,000&IJ0,000H IJ0,000

+ 18.6

b. Pro*i &ar+in raio

"rofit margin + 100- x ED!KLD G C"LA!T7: LF"L:DLH D!KLD

+ 100- x EI>1,.>0 & I1J4,>00H I>1,.>0

+ 6.;1

c. T#rno$er raio

Turnover ratio + 100- x :LT 7:*CML :LT D!KLD + 100- x IB,4>0 I>1,.>0 + 1

d. Re#rn on in$es&en /ROI0

AC7 + "AC7T M!A7: x TNA:CVLA + B641- x 1.- + ;.8

<. Wha is he payback period( Co&p#e he payback period *or an in$es&en re=#irin+

an iniia) o#)ay o* 8",""" %ih e'peced ann#a) cash in*)o%s o* 4","""

"ay%ac8 period is applied to figure out how many years to recover initial investments ! pro<ect

can re<ect if the pay%ac8 period is longer than re#uirement of the company 9owever, the

pay%ac8 period will not consider cash flow and ris8 of investment

Payback Period > iniia) in$es&en ? Ann#a) cash *)o%

+ J0,0000,000 + .B4 years

Thus, the pay%ac8 period in this case will %e .B4 years



. Wha is he acco#nin+ rae o* re#rn( Co&p#e he ARR *or an in$es&en ha

re=#ires an iniia) o#)ay o* 4"",""" and pro&ises an a$era+e ne inco&e o* 1"","""

!ccounting Aate of Aeturn is a measure or approach to calculate returns of investment or pro<ect

and it is unli8e cash flow %ecause it is %ased on accounting outcomes =esides, the results of this

method will show in percentage hen the percentage of accounting rate of return is high, the

profit of pro<ect or investment is high

!ccounting Aate of Aeturn (!AA) + !verage :et 7ncome 7nitial 7nvestment

+ 100,00000,000

+ -

Thus, the !ccounting Aate of Aeturn in this case will %e -

;. Wha is he ro)e ha he re=#ired rae o* re#rn p)ays in he NPV &ode)( In he IRR

&ode)(

The re#uired rate of return (AAA) is the minimum percentage return accepta%le to compensate

for a pro<ect's cost of capital and ris8

:"V method

or example, an investment of I1,000 today at 10 percent will yield I1,100 at the end of the

yearO therefore, the present value of I1,100 at the AAA (10-) is I1,000 The amount of

investment is deducted from this figure to arrive at net present value which here is ;ero (I1,000&

I1,000) ! ;ero net present value means the pro<ect repays original investment plus the re#uired

rate of return The higher the AAA, the lower the initial investment needs to %e in order to

achieve the target yield

7AA method

7AA or 7nternal Aate of Aeturn is the investorPs re#uired rate of return !t this rate the initial *ash

outlay for the pro<ect proposal e#uals the present value of expected net cash flows e also call

:"V will %e ;ero at 7AA



or example The 7nitial investment is I10,000 and expecting net cash flows at the end of each of

the next 6 years for I>,000 I6,000 I,000 and I1,000 and AAA is 11- The 7AA for this pro<ect

is calculated to 1663- when :"V 1663- + I0 !t 11- percent the :"V of the pro<ect is

IB00 which will ma8e the investment proposal a feasi%le choice 9owever, when :"V 1B-

is &I.6.46 ( a negative amount ) The role of AAA here is that when

• AAA is lower than 7AA will yield a positive :"V thus we will accept the pro<ect

• AAA is higher than 7AA will yield a negative :"V thus we will re<ect the pro<ect



R-5-R-NC-:

=a8er, 9Q and "owell, L (.00>) Understanding inancial Management! " #ractical Guide

1st edn, Massachusetts =lac8well "u%lishing

Moyer, *harlesO illiam QretlowO Rames Mcuigan (.011) Contem$orary inancial

Management (1.ed) insted Douth&estern "u%lishing *o pp 164G63J

atson, S, 9ead, ! (.010) Cor$orate %inance, >th edn, Kondon "rentice&9all

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Activity 9 Finanace _anh Giang