MERCADO, Erica Kaye M. Costram A2B November 13, 2019

MERCADO, Erica Kaye M.
COSTRAM
A2B November 13, 2019
1. What is the difference between independent projects and mutually exclusive projects?
2. Why is time value of money important in capital investment decisions?
3. Explain how the following is used in capital investment decisions.
- Payback Period
- Accounting rate of return
- Net Present Value
- Internal Rate of return (IRR)
4. Which of the above given tools is the best to use in making capital investment
decisions? Why?
Answers
1. There are two (2) types of project that are related to capital investment decisions
namely, independent projects and mutually exclusive projects. Independent projects
are projects that, if accepted or rejected, do not affect the cash flows of other
projects. For example, a decision by Jollibee Food Corporation to open a branch in
Lipa City does not affect its decision to open a branch in Rosario, Batangas. These
decisions are independent to each other and is therefore known as independent
capital investment decisions. Another type of capital budgeting project is the
mutually exclusive projects. These projects are those that if accepted, preclude the
acceptance of all other competing projects. For example, the simultaneous opening
of branches in Lipa City and Rosario, Batangas has mutually exclusive costs and
decisions that are accepted with regards to the equipment and processes of building
it. With the equipment and processes, once one type is chosen, it excludes the other
type presented.
2. As capital investment decision deals with the process of planning, setting goals and
priorities, arranging financing, and aspects concerned with long term assets, it is
important that the management is familiar with the related costs and consequences
of their actions. In order to determine the related costs of their decisions and
actions, time value of money plays a big role in the operations of the business. The
time value of money (TVM) explains why a dollar today is worth more than a dollar
promised in the future. This is for the reason that the value of money (versus other
denominations) is fluctuating and certain actions can be an advantage to increase
and propagate its purposes. This has something to do with present value and future
value of money. Through investments, a dollar today can be more than its value by
earning interest and capital gains. The value that will accumulate by the end of an
MERCADO, Erica Kaye M. COSTRAM
investment’s life, assuming a specified compound return is its future value. And the
amount needed today to accumulate its future value is its present value. This
concept of TVM is already a mode of profit itself. If management and investors are
aware of this, they can took advantage of the weakness and strength of a peso and
stock price (Philippine setting) in a good way. With regards to shares of stock, it is
best to acquire when it is weak, and best to sell- when it costs more than the call
price. The concept of TMV deals with the power of money, may it be on hand or is
invested.
3. The following concepts with regards to Payback Period, Accounting rate of return,
Net Present Value, and Internal Rate of return (IRR) affect the capital investment
decisions:
Payback Period
o It is one type of a non-discounting model wherein it deals with the
time required for a firm to recover its original investment. Commonly,
it is used to assess (1) financial risk, (2) impact of an investment on
liquidity, (3) obsolescence risk, and (4) impact of investment on
performance measures. It is the time needed to recover investment
at zero (0) profit. It affects the capital investment decisions for it gives
the time where the original investment can be recovered, may it have
even or uneven cash flows. It can be computed as follows:
Original Investment
Payback Period =
Annual Cash Flow
Accounting Rate of Return
o It is the second commonly used non-discounting model wherein it
measures the return on a project in terms of income, as opposed to
using project’s cash flow. Unlike the first method, it considers the
profitability of and investment, however, like the payback period, it
disregards the time value of money. It is the time needed to recover
the investment with profit. It affects the capital investment decisions
for it gives the time where the original investment with its profit can
be recovered, to ensure that debt covenants are not affected. It can
be computed as follows:
Average Income
Accounting Rate of Return=
Initial Investment
Net Present Value
o It is the difference between the present value of the cash inflows and
outflows associated with a project. It measures the profitability of an
MERCADO, Erica Kaye M. COSTRAM
investment with regards to time value of money. A positive NPV

indicates that the investment increases the firm’s wealth. Thus it
should be accepted, unlike with a negative NPV- that should be
rejected. In order to use this method, there must be a definite
required rate of return – it is the minimum acceptable rate of return.
It can be computed as follows:
NPV =¿
¿ [ ∑ CF t df t ] −I
¿ P−I
Internal Rate of Return
o It is defined as the interest rate that sets the present value of a
project’s cash inflows equal to the present value of the project’s cost.
In other words, the IRR is the interest rate where NPV = 0. This means
that the acceptable investments should have an IRR greater than the
required rate of capital. It can be computed as follows:
I =∑ [CF t ¿¿ ( 1+i )t ]¿
4. As I closely examine the aspects of these four (4) methods, the best method to be
used in accounting for capital investment decisions would be Net Present Value.
Even though that some readings suggested that the IRR is commonly used, NPV is
producing more accurate results that will be highly helpful for the operations of the
business. This is for the reason that the NPV uses and considers the time value of
money, with this not only the time needed to recover the initial investment is
obtained but most especially, the value of money that the possible profit indicates.
As it is the difference between the present value of the cash inflows and outflows
associated with a project, it measures the profitability of an investment. This will
clearly result to a negative or positive NPV, a positive NPV means that the project is
earning and that it is vital for the company. Having a negative NPV clearly means
that the company needs to improve operations and refrain from pursuing the said
project even more.

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