The internal Rate of Return discount rate

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The Internal Rate of Return (IRR) is the discount rate which will produce the net present value (NPV) of nil. The IRR represents the true interest rate earned on an investment over the course of its life. It is also used to rank projects to be used in management decisions. Projects that have an internal rate of return greater than the cost of capital are worthy of consideration.

A2

YEAR

Beta

Gamma

Delta

Investment

2010

-50,000

-100,000

-100,000

 

2011

10,000

35,000

0

 

2012

10,000

35,000

0

 

2013

10,000

35,000

0

 

2014

10,000

35,000

0

 

2015

10,000

35,000

0

 

2016

10,000

 

100,000

 

2017

10,000

 

100,000

 

2018

10,000

 

100,000

 

2019

10,000

 

100,000

 

2020

10,000

 

 

 

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2021

 

 

 

 

2022

 

 

 

 

2023

 

 

 

 

2024

 

 

 

 

2025

 

 

 

 

 

 

 

 

Internal Rate of Return

 

 

 

 

15%

22%

20.5%

 

 

 

A3

Rank

Project

IRR

1

Gamma

22%

2

Delta

20.5%

3

Beta

15%

4

Alpha

14%

5

Epsilon

12.5%

6

Zeta

12%

A4

Assuming a 10% rate of return is required for a £250000, £275000, or a £350000 investment, I would use project Gamma, as you can see from the results on the tables shown above, project Gamma, is showing the highest Internal Rate of Return, basically a true interest rate for the investment. However, when using the three limits available and the return amounts provided, most projects give a negative IRR apart from project Delta. Therefore, project Delta should be used in all three cases.

A5

Net present Value (NPV) is used to calculate the present value of cash flow, associated with an investment. It is a way of comparing the value of money now with the value of money in the future. Investments with a positive net present value are worth investing in and the higher the better.

A6

 

YEAR

Alpha

Beta

Gamma

Delta

Epsilon

Zeta

Investment

2010

-50,000

-50,000

-100,000

-100,000

-100,000

-25,000

 

2011

0

10,000

35,000

0

2,500

11,500

 

2012

5,000

10,000

35,000

0

7,500

10,000

 

2013

10,000

10,000

35,000

0

15,000

5,000

 

2014

10,000

10,000

35,000

0

25,000

5,000

 

2015

10,000

10,000

35,000

0

25,000

 

 

2016

10,000

10,000

 

100,000

25,000

 

 

2017

10,000

10,000

 

100,000

25,000

 

 

2018

10,000

10,000

 

100,000

25,000

 

 

2019

10,000

10,000

 

100,000

25,000

 

 

2020

10,000

10,000

 

 

25,000

 

 

2021

10,000

 

 

 

 

 

 

2022

10,000

 

 

 

 

 

 

2023

10,000

 

 

 

 

 

 

2024

10,000

 

 

 

 

 

 

2025

10,000

 

 

 

 

 

Internal Rate of Return

 

 

 

 

 

 

 

14%

15%

22%

20.5%

12.5%

12%

 

 

 

 

 

 

Net Present Value (assuming a 16% rate of return)

 

 

 

 

 

 

 

£43,418.06

£48,332.27

£114,600.28

£133,225.02

£82,022.21

£23,310.17

 

 

 

 

 

 

A7

Rank

Project

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NPV

1

Delta

£133,225.02

2

Gamma

£114,600.28

3

Epsilon

£82,022.21

4

Beta

£48,332.27

5

Alpha

£43,418.06

6

Zeta

£23,310.17

A8

Looking at both projects Gamma and Delta, I believe that it would be more sensible to use project Gamma, as it provides a better return of investment. The Internal Rate of Return is higher than the other projects and also gives a Net Present Value higher than the value capitalised, therefore meaning that this project would be worthy of investment.

A9

A10

There are several factors that need to be looked into before making a decision on a particular project, these include cost, time, quality, productivity, client satisfaction, regular and community satisfaction, people, health and safety, innovation and learning and environmental factors.

Although there are some uncontrollable factors that affect rankings include projects of similar size, type, duration, and nature, while factors are not easily measured, they must therefore be considered on a project-by-project basis.

B1

Project finance involves both an investment decision and a finance decision. Leasing is less capital-intensive than purchasing, so if a business has constraints on its capital, it can grow more rapidly by leasing property than it could by purchasing the property outright.

There are two types of leases, a finance lease and an operating lease.

A finance lease takes the full cost of the asset so takes on the rewards of ownership other than the legal title. It is therefore similar to a hire purchase agreement.

An operating lease pays a rental fee for the hire of an asset over a period of time. This lease does not take with it the responsibility of the maintenance, repairs, and insurance of the asset.

Leasing, as a source of finance for short to medium term goals, can be seen as a direct substitute for borrowing. This means, that, a business pays for the use of a product but does not have to own it. Leasing can provide the flexibility of obtaining essential equipment that might otherwise only be required for a short period or for a particular project and so does not warrant being purchased outright. A business may have a shortage of cash, or may prefer to use its cash for other purposes so they may not wish to keep an asset permanently so may buy on a lease. This undoubtedly helps effective business planning. The payments made are fixed and will not fluctuate as interest rate change. The leasing company who owns the equipment is responsible for its upkeep and maintenance adding to the attraction especially for small or medium sized companies needing to minimise the risk of any additional costs occurring.

C1

"The Accounting System and the careful use of accounting reports can contribute to effective motivation"

Accounting is the method in which financial information is gathered, processed, and summarised into financial statements and reports. The accounting system is the system that collects and stores the data and then processes it into reports. These reports provide information to help decision makers manage organisations more efficiently and strategically.

An accounting system can be a manual accounting system, although today, we use computer-based systems combining the resources and capability of information technology with traditional accounting methods and controls.

Financial statements are prepared from the information in your trial balance, which is constructed by the system, therefore the data must be correct. Valid reported information must be consistent, prompt, and accurate and relate to a specific time period.

Setting up a good accounting system and understanding the numbers produced can make a major difference in how your business goes in the long run. If the accounting system is updated correctly and efficiently, then the reports generated will provide staff and the business a true picture of where the business stands financially.

Motivation is the driving force which causes us to achieve goals. Therefore, when staff view the reports, it provides them with an incentive to achieve better results. As time evolves, staff become more motivated as they see good results coming in.

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Accounting records are important because the resulting financial statements and reports help you plan and make decisions. They may be used by some third parties (bankers, investors, or creditors) and are needed to provide information to government agencies, such as the Internal Revenue Service.