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The components of financial management
Finance & Accounting
Pages 10 (2510 words)
Student’s Name Institution Instructor’s Name Date PART A Section I Net Present Value (NPV) is defined as the present value of cash flows less the initial outflow. When making decisions on the viability of a project using NPV, the project is accepted whenever the NPV is positive and rejected when NPV is negative.
Year Cash flow Discount factor Present value 0 (? 2m) 1 (? 2m) 1 (? 1.5m) 0.909 (? 1.3635m) 2 ? 1.0m 0.826 ? 0.826m 3 ? 1.3m 0.751 ? 0.9763m 4 ? 1.8m 0.683 ? 1.2294m 5 ? 1.3m 0.621 ? 0.8073m 6 ? 0.6m 0.564 ? 0.3384m ? 0.8139m The NPV of the project is ? 0.8139m. This is a positive amount and therefore is an indicator that the project can be carried on. Section II Associated risks of the project The risk associated with a project may be defined as the variability that is likely to occur in the future returns from the project. Risk arises in investment evaluation because we cannot anticipate the occurrence of the possible future events with certainty and consequently, cannot make any correct prediction about the cash flow sequence. In the context of capital budgeting projects, risk results almost entirely from the uncertainty about future cash inflows, because the initial cash outflow is generally known. These risks result from a variety of factors including uncertainty about future revenues, expenditures and taxes. Therefore, to assess the risk of a potential project, the analyst needs to evaluate the riskiness of the cash inflows. There are three possible attitudes towards risk that can be identified. These are: (a) Risk aversion (b) Desire for risk (c) Indifference to risk A risk averter is an individual who prefers less risky investment. ...
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