The Allied Group Is Considering Two Investments The First In

The Allied Group Is Considering Two Investments The First Investment

The Allied Group is evaluating two investment opportunities: one involves purchasing a packaging machine, and the other involves acquiring a molding machine. The packaging machine, costing $14,000, is intended for packaging garments for shipping to customers. The molding machine, at a cost of $12,000, would be used to mold mannequin parts. Both machines are expected to have useful lives of five years, with no salvage value at the end of this period. The firm’s required rate of return or cost of capital is 15%. The cash flow projections for each project over the five-year period are provided below, with the objective of determining each project's payback period, net present value (NPV), and internal rate of return (IRR).

Paper For Above instruction

The evaluation of investment projects requires analyzing various financial metrics to determine their viability and alignment with the firm’s strategic goals. The payback period, net present value (NPV), and internal rate of return (IRR) are common metrics utilized by financial analysts and managers to appraise potential investments. Each of these measures provides unique insight into the profitability, liquidity, and risk profile of a project. This paper discusses the calculations and implications of these metrics for the two specific projects—purchasing a packaging machine and a molding machine—considered by The Allied Group, with detailed explanations of each calculation step.

1. Payback Period

The payback period measures the amount of time it takes for an investment to recover its initial cost from cash inflows generated by the project. It is a simple metric that indicates liquidity risk; the shorter the payback period, the sooner the initial investment is recovered.

To calculate the payback period, the cumulative cash flows are tracked annually until they equal or exceed the initial investment. For each project, the cash flows over five years are summed sequentially, and the year in which the cumulative cash flows surpass the initial outlay determines the payback period.

Assuming the cash flows for each year are as follows:

Note: Since actual annual cash inflows are not provided explicitly in the prompt, it is necessary to assume or calculate these based on the given cash flows to complete the payback period calculation. Typically, if cash inflows are consistent, the payback period is calculated as initial investment divided by annual cash inflow. If cash flows vary, the cumulative cash flow method detailed above is used.

2. Net Present Value (NPV)

The NPV is the difference between the present value of cash inflows and outflows over the life of the project. It accounts for the time value of money, discounting future cash flows at the firm's cost of capital (15%).

The formula for NPV is:

NPV = ∑ (Cash Flow in Year t) / (1 + r)^t - Initial Investment

where r is the discount rate (15%), and t is the year.

Applying this to each project involves calculating the present value of each year's cash inflows and subtracting the initial investment. Exact calculations depend on the actual cash flow figures, which should be provided or estimated based on data. A positive NPV indicates the project adds value and should be considered for acceptance.

3. Internal Rate of Return (IRR)

The IRR is the discount rate at which the NPV of the project becomes zero. It essentially reflects the project's break-even cost of capital, indicating the expected rate of return.

To calculate IRR, iterative methods or financial calculators are typically used, adjusting the discount rate until the NPV equals zero. Alternatively, software such as Excel’s IRR function can be employed by inputting the cash flows sequence.

Commercially, an IRR exceeding the firm's required rate of return (15%) would denote an acceptable or potentially profitable project, whereas an IRR below 15% suggests the project may not meet investment criteria.

Conclusion

In evaluating The Allied Group's investment options, calculating payback period, NPV, and IRR provides a comprehensive view of each project's financial attractiveness. The payback period measures liquidity risk, NPV assesses overall value addition, and IRR offers insight into expected profitability. Each of these metrics complements the others, allowing managers to make informed decisions aligned with the company's strategic and financial goals. Accurate calculations require detailed cash flow data for each year, emphasizing the importance of transparent and precise financial projections in capital budgeting decisions.

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