Discounted and non-discounted cash flow techniques Essay

Discounted and non-discounted cash flow techniques - Essay Example This report aims at appraising four different projects on the basis of both discounted and non-discounted cash flow techniques. After the relevant computations, one project will be advised to be acceptedThis report also highlights the projects appraisal techniques in detail such that every technique will be discussed and its strengths and weaknesses will be elaborated. One by one every project will be considered for appraisal and its relevant computations will be provided in the appendix. The decision as to which project is to be accepted lies basically on two broader grounds namely as financial and non-financial. Here the financial grounds are discussed such that financial grounds itself can be bifurcated on two basis which are discounted cash flow techniques and non-discounted cash flow techniques. The discounted cash flow techniques have both the absolute and relative techniques. The most popular absolute technique is Net Present Value (NPV) technique which has also been used in t his current analysis. The relative discounted cash flow techniques may have various forms in which the famous ones are Internal Rate of Return (IRR) and Profitability Index (PI). On the other hand, the non-discounted cash flow techniques consist of Payback Period, Urgency and Accounting Rate of Return (ARR). Discounted Cash Flow Techniques In this particular analysis, NPV, IRR and PI are used as discounted cash flow techniques to appraise the project whereas only Payback is used as non-discounted cash flow technique as other techniques cannot be used because the non-availability of the relevant data. The following discussion contains detailed explanation of discounted cash flow techniques. Net Present Value Net Present Value technique is the most famous project appraisal technique such that it explains the benefits of the project in an absolute financial sense. This technique provides an absolute figure as how much the project would earn given in its project life. This technique wor ks on the basis of discounting such that cash out flows and flows are discounted through an appropriate discount rate which is generally the weighted average cost of capital. In the way, the present value of all cash outflows and inflows are computed and then all the present values are summed up to obtain the Net Present Value of the project. Strengths The strength of this technique is that it provides an absolute amount which reflects the overall benefits that the project can provide now. This technique is also quite simple to calculate and quite easy to understand. Weaknesses The weaknesses include that the NPV of a particular project can exactly be equal to another project but both the projects may have significant differences in the magnitude of the cash flows. Another weakness of the technique is that it is based on the future expectations such that cash flows are projected with judgment. In case if the economic and financial situation changes, then the actual results may vary significantly from the estimates NPV. Comprehensive financial knowledge is also required to compute the NPV especially in those projects where tax implications have the key impact upon the generation of cash flows. Internal Rate of Return This discounted cash flow technique is also quite popular among the financial analyst such that it works on the basis of NPV. Internal Rate of Return is that rate at which the Net Present Value of a project becomes zero. This means that if the IRR is used as a discount rate instead of WACC which can produce a nil NPV. Hence if IRR exceeds than WACC, then the project can produce positive NPV. However, if IRR remains lower than WACC then NPV would also remain in a negative zone. Strengths The biggest strength of IRR is that it is a relative measure and a comparable one. It is also easier to understand the logic that works behind it. The interpretation of IRR is quite easy and this technique is also quite consistent with the objective of maximizing th e wealth of shareholders. Weaknesses There are many drawbacks of this