Complete 8 page APA formatted essay: Internal Rate of Return.
As mentioned in the case study, the directors of AP plc expects that the minimum return to be 10% of the borrowed funds, which is used as the discount rate in calculating the NPV of each project. The expected cash flow from each year is multiplied by the discount factor to arrive at the present value at year 0 i.e. at the time of the making of the investment. An investment whose NPV is positive is considered to be a rewarding one, whereas an entity does not venture an investment whereas the NPV of the cumulative cash flows is negative. Where the management has to rank the investments, with the objective of giving priority to the most rewarding ones, the investment with the highest NPV must be ranked first. Calculating Internal Rate of Return (IRR) is another method extensively used in the investment appraisals. IRR is a rate where the cost of investment, cash outflow, is equal to the cash inflows. The proposal with the highest IRR is considered to be the most rewarding one. Payback period is another method utilized in investment appraisal which calculates the time taken by the investment to generate enough cash inflows to recover the initial cost of the investment.
As per the calculations, the proposal with the NPV is proposal 5 ‘introduction of approved quality assurance scheme’ with the NPV of £195,355. An analysis of the proposal will also give an insight about the rewarding attribute of the proposal as according to the situation given, an initial investment of £ 70,000 will generate £ 70,000 per year for five years. The proposal has the NPV to cost ratio of 279%. The next investment having higher NPV is proposal 2 ‘Installation of a mainframe computer system’ having NPV of £ 70,192. The NPV of proposal 3, proposal 1and proposal 4 is £ 51,653, £ 50,033 and £ 20,653 respectively. As per IRR method of appraisal, the best option to invest is again proposal 5 with IRR of 97%. . .