Managing finance Essay Example | Topics and Well Written Essays - 2000 words

Managing finance - Essay Example As can be seen from the above table, Option 1 has a positive Net present Value at a discount rate of 10%, and negative NPVs at 20 and 25%. Option 2 has negative NPVs for all discount rates considered. Option 3 has positive NPVs for all the discount rates considered. The Internal Rate of return (IRR) is the rate at which the NPV is equal to 0.This rate can be determined by interpolating between two rates, one of which has a positive NPV and the other a negative NPV. Note: The NPV for all discount rates applied in the case of option 2 are negative. Hence the NPV corresponding to the lowest rate (10%) is used along with the undiscounted (i.e. 0% discount rate) cash flows to interpolate and arrive at the IRR. Various financial metrics are used to evaluate the feasibility of a project. Some of the popular metrics in use include the Payback Period, the Net Present Value (NPV) and the Internal Rate of Return (IRR). Payback period is one of the simplest methods for assessing the feasibility of a project and can be calculated quickly. The Payback period is the number of years it takes to recover the investment made in a project, and is calculated by interpolating between the two consecutive years when the cumulative cash flows from the project are respectively below and above the investment made. Suppose an investment of 100,000 results in cash flows of 20,000, 30,000, 40,000 and 50,000 in four years. The cumulative cash flows are 20,000, 50,000, 90,000 and 140,000. It is clear that the investment of 100,000 is recovered in the fourth year. The actual figure of payback period is calculated by interpolation between the last two figures. The disadvantage of the payback period is that it fails to take in account the time value of money. Time value of money arises from the fact that cash received at an earlier point in time is more valuable than the same amount of cash received at a later point in time. If one were to invest