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# Agency Relationship Within Business Finance Essay

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## Question 1

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“Agency Relationship Within Business Finance Essay”

## Net Present Value (NPV)

Suppose the desired interest rate of return is 10% per annum. Year Discount factor Cash flow PV 0 1 -100000 -100000 1 0.909 60000 54540 2 0.826 40000 33040 3 0.751 30000 22530 4 0.683 10000 6830

The NPV is \$16,940 which is positive. The returning on the investment is over the interest rate 10 per annum. The investment project should be taken. Advantage NPV can provide us absolute value when considering taking the project or not. It considers the time value of money that irrespective of the exact time at which the cash flow is made. Disadvantage NPV cannot apply on intangible benefits. The size of the investment has not been measured.

## Internal Rate of Return (IRR)

The NPV at 10% is \$16,940. If now the rate of return is 20%, the NPV will be \$-70. Year Discount factor Cash flow PV 0 1 -100000 -100000 1 0.833 60000 49980 2 0.694 40000 27760 3 0.579 30000 17370 4 0.482 10000 4820

The estimated IRR is 19.96%. (Formula: 10+(16940)x(20-10)/(16940+70)=19.96%) If we need 12% return on the investment, the project should be taken. Advantage it is a simple way to communicate the value of the investment to people who doesn’t know the estimation details. Disadvantage Unrealistic rates of return are given. For the above case, the investment is financially attractive and should be taken immediately. But in the real world, IRR of 19.96% implies there is an opportunity to reinvest future cash flows at 19.96%, rather than an actual return of 19.96%. IRR approach cannot be applied on mutually exclusive projects.

## The Payback Period

Year Project A Cumulative Cash Flow 0 -100000 0 1 60000 60000 2 40000 100000 3 30000 130000 4 10000 140000 The payback period is 2 years. The investment project is acceptable. Advantages It is easy to calculate and simple to use. Profitable opportunities for long-term investment will not be overlooked as they involve a shorter wait for revenues to flow. Disadvantage Time value of money and inflation are not considered. It only concerns the liquidity of the cash flow, not the effect on business profitability. It ignores cash flows beyond the cutoff date. It biased against long-term projects, such as research and development.

## The Profitability Index (PI)

According to the above calculation, we are using the figures to calculate the PI as shown in the table below. Initial investment \$100,000 NPV 16940 PV \$116,940 The profitability index is 1.1694. (Formula: (116940/100000)) Since the PI greater than 1.0, which means this project has positive NPV, the project should be taken. Advantage It is easy to understand and communicate. It considers all cash flows of the investment and the time value of money. Disadvantage It only can be used for divisible projects. It ignores the size of the investment.

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Agency Relationship Within Business Finance Essay. (2017, Jun 26). Retrieved December 5, 2022 , from

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