# The rate to be used to discount the cash inflows and

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-The rate to be used to discount the cash inflows and cash outflows is the Cost of Capital.Advantages:1.Emphasizes cash flowsDecision Rule: ACCEPT if NPV > Zero2.Recognizes the time value of money3.Assumes discount rate as reinvestment rateDisadvantages:1.It requires determination of the costs of capital or the discount rate to be used.2.The net present values of different competing projects may not be comparable because of differences in magnitudes or sizes of the projects.Profitability Indexis designed to provide a common basis of ranking alternatives that requiredifferent amounts of investment. It is also known as desirability index,present value index and benefit-cost ratio.Decision Rule: ACCEPT if PI > 1Present Value of Cash InflowsProfitability Index = ----------------------------------------------------Present Value of Cash OutflowsInternal rate of Return (IRR)is the rate return that equates the present value of cash inflows to present value of cash outflows. It is also known as discounted cash flowrate of return, time-adjusted rate of return or sophisticated rate of return.Guidelines in determining IRR:1.Determine the present value factor (PVF) for the internal rate of return (IRR) with the use of the following formula:PVF = Net Investment Cost / Net Cash Inflows2.Using the present value annuity table, find on line“n”(economic life) the PVF obtained in No.1. The corresponding rate is the IRR. If the exact rate is not found onthe PVF table, ‘interpolation’ process may benecessary.Advantages:1.Emphasizes cash flows.2.Recognizes the time value of moneyDecision Rule: ACCEPT if IRR > Cost of Capital or the Minimum Required Rate of Return3.Computes true return on projectDisadvantages:Downloaded by Izzabelle Athena Jayo ([email protected])lOMoARcPSD|17126366
1.Assumes that IRR is the re-investment rate.2.When project includes negative earnings during the life, different rates of return may result.EXERCISES:Exercise 1.Net Investment for Decision MakingExercise 7. Bail-out Payback PeriodA project costing P180,000 will produce the following annual cash benefitsand salvage value:YearCash BenefitsSalvage Value1P 50,000P 65,000250,00050,000350,00035,000450,00020,000Required: Bail-out Payback Period =2.9 years180,00050,000 (1styr)50,000 (2ndyr)= 80,000 to be recovered on the 3rdyr.;On the third, there is SV 35,000 and NCR 50,000, which in total exceedsP80,000. Therefore within the 3rdyear.= 80,000SV 35,000 = 45,000;= 45,000/50,000 = 0.9BOPP =2.9 yearsDecision: REJECTS because it is longer than 4/2.Bicol Co. plans to replace a unit of equipment that was acquired three (3)years ago and is now recorded at a net book value of P65,000. This equipmentcan be sold now for P75,000. Tax rate is 30%.CASH-IN =P75,000 PROCEEDSGAIN = (P75,000-P65,000) = P10,000; Tax consequence = (30% x P10,000)CASH-OUT =P3,000 TAXNew equipment can be acquired from Isabela Co. at a list price ofP200,000.Isabela will grant a2% cash discountif the equipment is paid for worth 30days from acquisition date. Shipping, installation and testing charges to bepaid are estimated at aP17,500.

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