Principles of Financial Investment (Essay Sample)

Principles of Financial Investment
Student Name
Student Id
Module Name
Session
Name of Faculty
Table of Contents
1A…………………………………………………………………………………………3
1B…………………………………………………………………………………………3
1C…………………………………………………………………………………………3
2A…………………………………………………………………………………………4
2B…………………………………………………………………………………………4
2C………………………………………………………………………………………….5
2D………………………………………………………………………………………….5
2E…………………………………………………………………………………………...8
2F…………………………………………………………………………………………...10
References………………………………………………………………………………….11
Principles of Financial Investment
1A.
Time value of money is a concept that explains the sum of money is more worth now than the sum that it will be at a future date due to the earnings potentials in the interim. Concept of Time value of money explains that sum of money in the hand now has a greater value today than the sum of that money in the future. Money can only grow through investing and so the concept of time value of money consider amount of money to be invested, its future value as per the amount it can earn and also its timeframe.
1B.
Present value concept can be explained by stating that an amount of money today is worth more than that same amount in the future. Present value holds that money that is received today is not worth as much or an equal amount received today. Present value covers interest rates that an investment might have earned
1C.
Concept of future value is explained when the value of a current asset at a future date is determined based on an assumed rate of growth. The concept of future value explain that sum of money that is invested today will become overtime at a rate of interest.
2A.
Payback period

Cashflow

Cumulative cash flow

0

(95000)

(95000)

1

30000

(65000)

2

35000

(30000)

3

35000

50000

4

35000

40000

At the end of the second year =30000/35000
PBP=2 Years+0.8571
=2.8 years
2B.
Net present value
NPV= (95000) +30000/(1+r) ^1+35000/(1+r) ^2+35000(1+r) ^3+35000(1+r) ^4
(95000) +30000/ (1+0.11)^1+35000(1+0.11)^2+35000(1+0.11)^3+35000(1+0.11)^4
(95000) +30000(1.11) ^1+35000(1.11) ^2+35000(1.11) ^3+35000(1.11) ^4
(95000) +27027.03+28406.79+2559.70+23055.58
(95000) +104081.10
=9081.10
2C.
Profitability Index
PI=Summation of the present values/Investment
NPV of year 1-27027.03
NPV of year 2-28406.79
NPV of year 3-25591.70
NPV of year 4-23055.58
Total =104081.10
Investment=95000
Profitability Index=104081.10/95000
=1.095
NPV=1.10(2dp)
2D.
Internal rate of return (IRR)
The internal rate of return makes the NPV=0
IRR=ra+NPVa/NPVa-NPVb(rb-ra)
Key:
Ra-lower discount rate
Rb-higher discount rate
Na-NPVat ra
Nb-NPV at rb
Calculating NPV using trial and error method
Time

Cashflow

PV @ 10%

PV @17%

0

(95000)

(95000)

(95000)

1

30000

27272.72

25641.03

2

35000

28925.62

25567.97

3

35000

26296.02

21852.97

4

35000

23905.47

18677.75

Net present value


11399.84

-3260.28

Calculation of NPV using 10%
Year 1
30000/(1.10)^1
=27272.73
Year 2
35000/(1.10)^2
=28925.62
Year3
35000(1.10) ^3
=26296.02
Year 4
35000(1.10) ^4
=23905.47
Calculation of NPV using 17%
Year 1
30000(1.17) ^1
=25641.03
Year 2
35000(1.17) ^2
=25567.97
Year 3
35000(1.17) ^3
=21852.97
Year 4
35000(1.17) ^4
=18677.75
IRR=10%+11399.84/(11399.84+3260.28)*(17%-10%)
IRR=15%
2E.
Payback period
The payback period is a simple calculation of time that involves the initial investment to return. Unlike other techniques of capital budgeting, it ignores the time value of money. This technique is used alongside other techniques in capital budgeting because it only shines little information on the project feasibility, requiring more analysis to be done from other techniques and not relying on an outcome that it brings on board solely. The payback period has the following other features (GergRakesh,2009). One of which is easy to calculate and understand, whereas it does not involve complex, which makes it easy to handle. The second feature is that it shines upon little information on the project feasibility, and further analysis needs to be done.
Net present value
Net present value is a financial technique used to cover the total values of investment opportunities. This technique touches on the potential future cash flows and inflows that investment is associated with. The idea behind it is to discount all the future cash today and then add them together later (Sahu,2011). With a positive NPV, the investor pays a lesser amount than the worth of the asset itself. Negative NPV means that the investor pays more of what the asset is worth. When the NPV is at zero, then the investor pays exactly what the asset is worth.
Profitability Index
The profitability index is calculated when the present value of future cash flows that the project generates divided by the project's initial cost or investment. A profitability index of 1 will indicate that the project will break even; however, when it is less than 1, the costs of the project will outweigh the benefits (Jain & Manoj,2008). Other features indicate that the profitability index is an evaluator on all cash flows. Another feature is a measure to show if the investment increases