Applying Different Investment Decision Rules When Facing with the Choice of Investing Funds - Coursework Example

In short, the risk-adjusted discount rate approach can apply in using the internal rate of return (IRR) as well as the (NPV). (NPV) when used, the projected cash inflow is discounted at the risk-adjusted discount rate (Gitman, 2009).The (NPV) decision rule, says that acceptance of projects, only the projects with NPVs>$0; for example will qualify. If the initial investment (CF0) is known with absolute certainty, the project risk is in the present value of its cash inflows. Two opportunities to adjust the present value of cash inflows for risk are recognized today (Gitman, 2009).

• cash inflows or (CFt) can be adjusted• the discount rate (r) can be more popular a process of adjusting the discount rateWhen determined, the portfolio effects of project analysis and the practical aspects of the risk-adjusted discount rate. This is because adjusting the cash inflows is highly subjective. The most popular process is the risk-adjusted discount rate. If NPV > zero 􀃎 Accept projectIf NPV = zero 􀃎 indifferenceIf NPV < zero 􀃎 Reject projectWithout such as adjustment management tool, could mistakenly accept projects that destroy shareholder value or could reject projects that create shareholder value (Gitman, 2009).2. Discuss the pros and cons of applying different investment decision rules when facing the choice of investing funds.

The pros and cons are in the method used. It depends on the size and scope of the firm. It depends on what projects the firm is willing to take on. Dollar-Cost Averaging is an investment strategy involving the regular deposit into a particular investment at regular intervals over a period or (DCA), (Gitman, 2007).Weighted Average Cost of Capital or (WACC) is straightforward. By multiplying, the specific cost of each form of financing by its proportion in the firm's capital structure implies a sum called the weighted values.

This is by small (r) little (a). WACC reflects the expected average future cost of funds over the long run. This is found by weighting the cost of each specific type of capital by its proportion in the firm's capital structure (Gitman, 2009),Any firm's weighted average cost of capital is a key input to the investment decision-making process. (EVA) or economic value added is another popular measure that firms use to determine whether an investment proposes through existing data that directly contributes to the shareholder's wealth theory.

The use of (NPV) is a dynamic approach to investment decisions. It recognized that the volume of financing and the investment firm chooses can affect that investment at any given time, the firm financing costs and investment returns. The (WACC) and the investment opportunity schedule, (IOS) are mechanisms whereby financing and investment decisions are made simultaneously (Gitman, 2009).3. Discuss the different approaches in choosing between projects. As long as a project's internal rate of return is greater than the weighted marginal cost of new financing, the firm should accept the project.

The return will naturally decrease with the acceptance of more projects and the weighted marginal cost of capital or (WMCC). The weighted marginal cost of capital will increase because greater amounts of financing are required; therefore using a combination of tools such as WMCC or the IOS (investment opportunity schedule) helps a company make wiser financing and investment decisions. When using these tools actually proves, the investor has a linkage between theory and practice. United States corporations are increasingly using these types of tools to accurately measure all costs of capital and therefore make better capital budgeting decisions (Gitman, 2009).4. Explain why choosing the option with the highest NPV is not always the best decision for the company.

Provide examples.Firms that use the NPV approach take what it measures in both the inflows and outflows; not income. This is to accept or reject, to make a financial decision. The criterion says if the NPV is greater than $0 accept the project; if the NPV is less than $0 reject the project. The objective will be to identify the decision yielding the best results. As a result, the 80/20 philosophy is not always the optimum strategy and good business. The decision rule is to accept the projects with the highest internal rates.

This contrasts with NPV, which has a general decision rule of accepting/rejecting the project (Eiteman, 2007).Here is an example for a firm. Do they buy a new truck or fix the damaged one.We can conclude in capital budgeting decisions that they are not much different from the whole of managerial accounting. There are many tools at disposal of firms.