3. What Aspects of the Projects Might Invalidate the Ranking You Just Derived? How Should We Correct for Each Investment’s Time Value of Money, Unequal Lifetimes, Riskiness, and Size?

What aspects of the projects might invalidate the ranking you just derived? How should we correct for each investment’s time value of money, unequal lifetimes, riskiness, and size?

The aspect of the projects that could invalidate the derived rankings would be the expected free cash flows. “Free Cash Flow is used to buy materials and/or pay wages. Some of the cash pays the bills. If the company is doing well, there will be cash remaining after all expenses (including taxes) are paid. This cash can be paid out as dividends, reinvested in the company, or invested in the market. The company could also choose to buy some of their shares back.” (Little, K. 2012. p1). Since the NPV and free cash flows are so closely intertwined in regards to ROR, the proposal with the most incoming free cash flow within ten years could derail the derived rankings based on NPV. Regarding the case of expected free cash flow, the Strategic Acquisition Proposal would still rank the highest within 10 years.

The way to correct for each investment’s time value of money, unequal lifetimes, riskiness, and size would be to analyze the overall capital budget by combining the NPV, cash inflows and cash outflows to determine if the proposals compensations are worth the risks. Since the IRR is the rate of return, an investor can expect to earn on an investment and the majority of the proposals are expecting to yield high IRR’s with NPV’s at Minimum ROR’s in the positive; also, as the answer states for question #2, “the Equivalent Annuity utilizes the same data as the NPV at Minimum ROR AND it also corrects for project durations,” the board may find that the value of money and size of the proposals, etc. may be worth the risks.