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Spreadsheets DCF1 and DCF2 provide a complete analysis of new project cash flow and other financial metrics that are significant when making investment decisions. DCF1 computing assumes that the project will allow for the production of a new product as well as contract manufacturing; DCF2 computing only considers new product revenues and costs.
Based on my study, I propose approving the project in both the first and second options. Nonetheless, the first option (engaging in contract manufacturing) is preferable because its parameters are more promising.
The IRR and NPV are key figures in the offered models for determining project profitability. NPV (net present value) is a difference between total discounted inflows and outflows of the project, this parameter considers the time value of money. For a DCF1 version of the project, its value is $3117195.237; the figure is positive that means the project may be accepted. For a DCF2 version of the project, its value is $2251540.081; the figure is positive too that mean the project in this version may be accepted too. However, the positive outcomes of the DCF1 version are higher that makes that version of the project preferable.
IRR (internal rate of return) is annualized effective compounded return rate that represents predicted the rate of return making the net present value of the project equal 0. For the DCF1 project, this value is 75.5%, for the DCF2 project it is 59%. The higher is IRR the more competitive the project is in comparison to other forms of investments. Therefore, both projects may be accepted, their IRR values are very high, but the first variant is more preferable.
It is important to note that parameters applied in the analysis to make decisions about project acceptance has their limitations. Therefore, it is better to use them in combination with other analysis techniques and take in account additional factors making prediction stricter.
In particular, IRR as a tool for investment decision-making is comparable with NPV by its reliability but can provide different results when sorting projects by their profitability. Calculated IRR is not recommended for application for choosing between mutually exclusive projects when the objective is to maximize total value, in particular for ones with different duration. NPV calculations have such pitfalls as:
- underestimation of losses on late years of the project,
- the way of risk adjustment through premiums to the discount rate,
- compounding of risk premiums not related to reality,
- potentially dynamic change of rates in the system.
In general, NPV is academically preferable, while practitioners prefer IRR. In our case, both parameters lead to same conclusions, so it does not produce any problems.
Around additional factors, I would recommend using in the analysis, lost sales and variable costs related to them. This way you take into account not only real inflows and outflows but also alternative ones that make economic analysis deeper.
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