Harding Case Stuy

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DPP = Year before DPP occurs + Cumulative cash flow in year before recovery/discounted cash flow in year after recovery

DPP for Nano Test Tubes = 4 + 282.15/4064.30 = 4.07 years

DPP for Microsurgery Kit = 3 + 1052.59/1679.46 = 3.63 years

- The rationale behind the discounted payback method is to consider the time value of money. It basically considers the future less value of the money at present moment. The concept is similar to net present value (NPV) but only considers the period of payback.

- Advantages of Discounted Payback Method:

- Considers the time value of money

- Considers the riskiness of the project’s cash flow (through the cost of capital)

Shortcomings of the Discounted Payback Method:

- Require an estimate of the cost of capital in order to calculate the payback

- Ignores he cash flows beyond the discounted payback period

- No concrete decision criteria to indicate whether the investment increases the company’s value

Question 3

Time of Cash Flow

Nano Test Tubes

Microsurgery Kit

Present Value

Accumulated DCF

Present Value

Accumulated DCF

Investment

$ (11,000.00)

$ (11,000.00)

$ (11,000.00)

$ (11,000.00)

Year 1

$ 1,818.18

$ (9,181.82)

$ 3,636.36

$ (7,363.64)

Year 2

$ 2,479.34

$ (6,702.48)

$ 3,305.79

$ (4,057.85)

Year 3

$ 3,005.26

$ (3,697.22)

$ 3,005.26

$ (1,052.59)

Year 4

$ 3,415.07

$ (282.15)

$ 2,732.05

$ 1,679.46

Year 5

$ 4,346.45

$ 4,064.30

$ 2,483.69

$ 4,163.15

NPV for Nano Test Tubes after 5 years = $ 4064.30

NPV for Microsurgery Kit after 4 years = $ 1679.46

- Rationale behind the NPV method is that it consider the time value of money. The concept is similar to that of Discounted payback method, but it dwell on the final money amount garnered by adding all the discounted cash flows together, as opposed to the latter which is on the period of time.

- The decision rule behind the NPV method is as follow:

NPV > 0, ACCEPT the project

NPV

If the NPV is positive, then approve the project. It shows that you are making more money on the investment than you are spending on your cost of capital. If NPV is negative, then do not approve the project because you are paying more in interest on the borrowed money than you are making from the project.

- The general rule to rank mutually exclusive projects is as follow:

NPVA project A > project B, Choose project A.

The higher the NPV value shows the more money you are making on the investments than you are spending on your cost of capital. As such the highest NPV project value is chosen. In this case, project Nano Test Tubes shall be chosen, with highest NPV value of $ 4064.30.

- Advantages of Net Present Value (NPV) method:

- Shows whether the investment will increase the company’s value

- Considers all the cash flows

- Considers the time value of money

- Considers the risk of future cash flows (through the cost of capital)

Shortcoming of the Net Present Value (NPV) method:

- Requires an estimate of the cost of capital in order to calculate the net present value

- Expressed in terms of dollars, not as percentage

- Should the discount rate be adjusted upward for projects of higher risk, the NPV will tend to decrease. This truly reflected by the nature of the project riskiness. On the other hand, should the discount rate be adjusted downwards, the NPV is expected to increase, and thus reflects on the lower level of riskiness of the project.

Question 4

Time of Cash Flow

Nano Test Tubes

Microsurgery Kit

Present Value

Present Value

Investment

$ (11,000.00)

$ (11,000.00)

Year 1

$ 1,818.18

$ 3,636.36

Year 2

$ 2,479.34

$