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The components of financial management

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. The basic assumption in financial theory is that most investors and managers are risk averse. Risk seekers on the other hand are individuals who prefer risk. Given a choice between more and less risky investments with identical expected monetary returns, they would prefer the riskier investment. The person who is indifferent to risk would not care which investment he or she received. There are various risks involved in the project that have different degrees of consequences. Such risks may be categorized into technical risks, environmental risks, economic risks, political risks and project completion risks. (Horngren, Foster, & Datar, 2001) The risks that any project is predisposed can be avoidable or unavoidable and therefore a firm has to minimize the risks that face the projects it undertakes as much as possible. The project that is intended to be carried out can face the risk of errors in estimation. Such errors could disrupt the schedule of the whole project as a whole if the business and development teams do not work closely to curb such cases of errors. There is also the possibility that there can be a requirements overload whereby the requirements for the project are not well established and are therefore constantly being added later on during the development phases of the project. This disrupts the laid down schedule and delays the events of each step of the project. Lack of proper documentation of the project at the same time as the project progresses is also a risk that most projects face since critical information related to the project may be lost. PART B Section I Beck Bag Year Expected cash flows Accumulated cash flows 1 60,000 60,000 2 70,000 130,000 3 70,000 200,000 4 40,000 240,000 5 20,000 260,000 The project costs 200,000 and the amount is recouped in the third year, therefore the payback period is 3 years. Roo Bag Year Expected cash flows Accumulated cash flows 1 70,000 70,000 2 70,000 140,000 3 60,000 200,000 4 60,000 260,000 5 60,000 320,000 The project costs 260,000 and it takes 4 years to recoup this amount. Therefore the payba ...Show more
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Summary

Institution 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…
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