Pyramid Printing Company's Controller Pete Roberts And Produ
Pyramid Printing Companys Controller Pete Roberts And Production Ma
Pyramid Printing Company’s controller, Pete Roberts, and production manager, Darrell Dailey, once again discuss potential operational improvements that may improve results. After successfully implementing JIT and subletting the space, Pyramid was flush with cash. As a result, Darrell inquired whether it was time to purchase another press. Henry Russell, Pyramid Printing’s sales manager, suggested that the market be tested to ensure the press would be full in terms of capacity prior to use. Pete and Darrell then discuss their choice of decision model; Pete prefers net present value, and Darrell prefers internal rate of return.
Consider the use of these models. Which model is better for use? Are there circumstances in which one must be concerned regarding the outcomes of these two decision models? Do these models both deliver the same level of accuracy for decision-making? Required: Half to one page only with at least 2 references
Paper For Above instruction
The decision to purchase new equipment, such as an additional printing press, involves critical financial evaluation methods. The two primary models in question are Net Present Value (NPV) and Internal Rate of Return (IRR), each with distinct advantages and limitations. Assessing which model is more appropriate depends on the context of the decision, specific project characteristics, and the potential for conflicting outcomes.
Net Present Value (NPV) is often considered the superior method for investment decisions due to its straightforward approach of discounting all expected cash flows to their present value using a predetermined discount rate. It directly measures the expected increase in wealth that a project would bring to the company, making it a valuable tool for decision-making under uncertainty (Berk & DeMarzo, 2020). When evaluating a capital expenditure like purchasing a new press, NPV provides a clear indication of the dollar value that the project is expected to add, thus aligning with shareholders’ interests.
In contrast, the Internal Rate of Return (IRR) calculates the discount rate at which the present value of cash inflows equals the initial investment, effectively representing the project's expected rate of return (Ross, Westerfield, & Jordan, 2019). IRR is intuitively appealing because it provides a percentage return that is easy to compare against the company's required rate of return or cost of capital. However, IRR can sometimes give conflicting signals, especially when evaluating mutually exclusive projects or projects with non-conventional cash flows, resulting in multiple IRRs or misleading rankings (Fernández, 2019).
Circumstances where one must be cautious about these models include situations with multiple or unconventional cash flows, where IRR might produce multiple rates or be misleading. Additionally, IRR assumes reinvestment of intermediate cash flows at the IRR itself, which can be unrealistic, whereas NPV assumes reinvestment at the firm's cost of capital, making its projections more conservative and arguably more reliable for decision-making (Damodaran, 2015).
Regarding accuracy, while both models aim to offer insights into a project's profitability, NPV generally provides a more precise estimate of value added. IRR can sometimes be ambiguous or overly optimistic, particularly when comparing projects with different durations or scales. Therefore, relying solely on IRR may lead to suboptimal decisions, whereas NPV offers a more consistent measure aligned with shareholder wealth maximization.
In conclusion, while both models are valuable tools, NPV is generally considered more reliable for capital budgeting decisions such as purchasing a new press. Decision-makers should be aware of the specific circumstances and limitations of each method to avoid potentially misleading outcomes.
References
Berk, J., & DeMarzo, P. (2020). Corporate Finance. Pearson.
Damodaran, A. (2015). Applied Corporate Finance. Wiley.
Fernández, P. (2019). Valuation and Common Sense. Academic Press.
Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2019). Fundamentals of Corporate Finance. McGraw-Hill Education.