Final answer:
The Internal Rate of Return (IRR), Net Present Value (NPV), and Profitability Index (PI) are capital budgeting techniques used to assess the financial viability of an investment project. NPV considers the time value of money and provides a dollar value for the project's profitability. MIRR is an alternative to IRR that accounts for the reinvestment of intermediate cash flows. PI provides a relative measure of profitability, but does not provide a dollar value. Capital budgeting risk can be assessed using sensitivity analysis and scenario analysis.
Step-by-step explanation:
The Internal Rate of Return (IRR) is a capital budgeting technique that calculates the discount rate at which the net present value (NPV) of an investment project is equal to zero. In this case, the IRR would represent the minimum rate of return required for the MBA program to be considered a good investment. The Net Present Value (NPV) is another capital budgeting technique that calculates the present value of all future cash flows associated with an investment project. The NPV of earning an MBA at UMass Global would be the present value of the $10,000 annual salary increase for 5 years, minus the initial cost of the program. Finally, the Profitability Index (PI) is a ratio that measures the present value of future cash inflows relative to the initial investment. The PI of earning an MBA at UMass Global would be calculated by dividing the present value of the $10,000 annual salary increase for 5 years by the initial cost of the program.
The pros of using NPV as a capital budgeting technique include that it considers the time value of money, it provides a dollar value for the project's profitability, and it allows for comparison of different projects. The cons of using NPV include that it relies on accurate cash flow estimations, it assumes cash inflows are immediately reinvested at the discount rate, and it does not consider qualitative factors.
MIRR stands for Modified Internal Rate of Return and is an alternative to IRR that accounts for the reinvestment of intermediate cash flows at a different rate. The advantage of using MIRR is that it addresses the reinvestment rate assumption of IRR, but it is less commonly used and can be more complex to calculate.
The pros of using Profitability Index include that it considers the time value of money and it provides a relative measure of profitability. The cons of using PI include that it does not provide a dollar value for the project's profitability and it does not consider qualitative factors.
Capital budgeting risk refers to the uncertainty associated with the cash flows of a capital project. Two methods used in capital budgeting to identify uncertainties are sensitivity analysis and scenario analysis. Sensitivity analysis involves testing the impact of changes in key variables (e.g., sales volume, costs) on the project's NPV. Scenario analysis involves estimating the NPV under different scenarios, such as optimistic, most likely, and pessimistic scenarios. These methods help assess the risk and potential outcomes of a capital project.