Investment Decisions Harvard Case Solution & Analysis

Ranking before Calculation& Analytical Criteria

Ranking before any calculation is done by using the sum of net cash flows over initial investment. The initial requirement for each project is same; therefore it is possible to rank the project on the basis of cash flows. The project, which is generating highest net cash flow, is on the first ranking like the project number 3 as it is generating the net cash flow of 8000 dollars,which is highest among the others and project two is on the eighth ranking because it is generating the lowest net cash flow of 165 dollars.

 Although this ranking is performed by ignoring the time value of money while incorporating the time value of money, however the ranking will be different because each project has different life span.

Comparison of project 7 and 8

Both of the projects require equal amount of initial investment without performing any calculation.Project 7 is at ranking 6 asit is generating the net cash flows of 560 dollars and project 8 is at ranking 3 asit is generating the net cash flow of 2150 dollars.

However,on the basis of payback period, project 7 is at ranking 2 because it is paying back the business its initial investment in the start of 2nd year, whereas the project 8 is at ranking 5 asit is paying back the business its initial investment in the mid of 7th year.

Both 1st and 2nd methods ignore the time value of money, as payback period calculates only the year in which cash flows become positive. In order to identify the attractiveness of these projects, these methods are not appropriate and are giving different results.The most suitable method is calculating the profitability index of each project. It is calculated by dividing the net present value of the project with the initial investment of the project. Net present value of the money calculates the time value of money of each cash follow being received at different intervals. By incorporating the time value of money factor gives more realistic and real results by discounting the future cash flows at a suitable discount rate.

In order to identify the profitability index, net present value of both projects is calculated by using 8% as a discount rate; therefore on this basis project 8 is more attractive as compared to project 7.

Sensitivity of ranking using High Discount Rate

Initially, the ranking of the projects is performed by identifying the net present value of each project at discount rate of 8% and by identifying the profitability index for each project. When the net present value of the each project is calculated using the high discount rate of 12%, it gives the different results as initially project 8 was more suitable because it was generating more net present value and profitability index on the discount rate of 8%.On the other hand, while on 12% the project 8 is yielding less net present, therefore the projects are more sensitive and will yield different results if higher discount rate is used.Investment Decisions Case Solution

NPV and IRR Disagree

On the basis of net present value, the project 8 is more suitable as it is generating higher NPV than project 7 whereas,on the basis of IRR the project 7 is more suitable because it is generating the rate of return of 15%.On the other hand, project 8 is generating the internal rate of return of 11%. This could be due to the size of the project and time value of money. Project 7’s useful life is 5 years and of 8th is 7 years; therefore IRR for the project is disagreeing with the NPV.

Payback and NPV not agree

Net present value and payback period of the projects give different results. For example,on the basis of net present value the project that generates more NPV is at the lowest ranking according to the payback period and vice versa.

This is because the payback period measures only the years in which cash flows become positive. Moreover, it does not incorporate the time value of money whereas, the net present value method accounts for the time value of money and discounts the future cash flows at a suitable discount rate and gives more realistic value in today’s term, which also helps a lot while evaluating the investment projects......................

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