Computation of Tremendous Net Present Value and IRR †Free Samples

Question: Discuss about the Reasons for consideration of proposal despite the computation of tremendous Net Present Value (NPV) and Internal Rate of Return (IRR). Answer: According to the provided case study, Ed Draycutt is the engineering manager of Airway Technologies. This organisation is involved in making computer systems for control installations of air traffic at the airports. The person has proposed a new device and the success is reliant on two distinct events. This device would cost $20 million; however, this has been a considerable investment for the organisation. However, the organisation could incur serious losses and it might result in liquidation, if the system fails to work. However, there are certain risks associated with the proposal despite the positive values of NPV and IRR. The major problem associated with this is that there has been no depiction of 4% probability in the presentation that the organisation might lose $20 million. Hence, this necessitates the organisation to re-consider the business proposal with other techniques for evaluating the actual feasibility of investment (Baum Crosby, 2014). Although both NPV and IRR are considered the best measures of investment appraisal, however, these methods have certain limitations. The NPV method does not take into account the negative effects of inflation, which might reduce the profitability and productivity of an investment appraisal (Dyson Berry, 2014). On the other hand, the internal rate of return fails to take into account the time value of money. In addition, this method also fails to consider the negative impact of inflation, which might negatively influence the scope of the investment appraisal (Gtze, Northcott Schuster, 2015). Moreover, the project size could not be gauged with the help of the method of net present value. Another disadvantage associated with the method of internal rate of return is that it could lead to conflicting results for mutually exclusive projects. Moreover, Ed Draycutt has not added the method of including risk premium to the rate of discount. This is intended mainly to adjust the risk, which could increase the cost artificially or incorrectly (Gtze, Northcott Schuster, 2015). Moreover, when the incorporation of risk premium is made into the discount rate, it results in compounding impact from additional risk premium. As a result, such compounding effects could lead to a lower NPV. Hence, Airway Technologies might incur severe losses, if it adopts the proposed system. However, it has been observed that if the system A is not adopted, the Airway could lose the entire amount invested in the development of new service. Furthermore, if the industrial standard requires the system A, it would help the organisation to become the market leader, as o other organisation has the similar device available. Hence, in order to evaluate the feasibility of the proposed investment, Airway Technologies is required to consider the inflationary effects and the probability factor by reducing the estimates of cash flows by 4%. Such technique would help in minimising the overall project risk and hence, appropriate decision could be undertaken regarding the commencement of the proposed investment on system A. References: Baum, A. E., Crosby, N. (2014).Property investment appraisal. John Wiley Sons. Dyson, R. G., Berry, R. H. (2014). Capital investment appraisal.Developments in Operational Research: Frontiers of Operational Research and Applied Systems Analysis, 59. Gtze, U., Northcott, D. Schuster, P. (2015). Capital Budgeting and Investment Decisions. InInvestment Appraisal(pp. 3-26). Springer Berlin Heidelberg. Gtze, U., Northcott, D., Schuster, P. (2015).Investment appraisal: methods and models. Springer.