Question

1. Which division is making the best use of invested assets and should be given priority for future capital investments? 2. Assuming that the minimum acceptable return on new projects is 19%, would all investments that produce a return in excess of 19% be accepted by the divisions? Explain. 3. Identify opportunities for improving the company’s financial performance.

Answer 1

1. The division which has the best Net Present Value (NPV) on its present investments should be given priority for future capital investments (A generalized answer because the question does not have a context attached)

2. In a perfect world, all such projects should be accepted if they are no scarcity of funds (As per the IRR method). Unfortunately in real world, we have a scarcity of resources so we have to choose only the ones that give you maximum return.

3. The company's financial performance can be improved by investing in positive NPV projects

Step-by-step explanation:

Net Present Value is your discounted returns(discounted cash inflows) minus the investment (cash outflows), thus, giving you essentially the value that the project creates for the company i.e, thus increasing the size of the pie the company holds. Thus, Projects with NPV>0 are accepted.

IRR gives you the investment's rate of return, if that is higher than the discount rate or minimum acceptable rate, you should ideally accept the project. NPV method is better than Internal Rate of Return (IRR) method because IRR method ignores project duration, future costs, or the size of a project. Thus, when choosing among projects (capital budgeting), NPV method is preferred.

But in real life, not all such projects with NPV>0 and IRR>minimum acceptable rate are accepted because of the scarcity of the funds.