Calculation Questions On Deposits, Loans, Annuities, Bonds And IRR Method

Question 2

Question 3:

a) Annual nominal yield of bond:

The difference between effective and nominal rate is the frequency in which both are charged, where from the calculation it could be detected that effective rate is changed as the same frequency, while nominal rate of interest is charged frequently. Hence, it cud be detected that the that nominal rate of interest if without compounded, while effective rate is compounded.

b) The annual rate of return on each of the indices:

The major difference between the price index and accumulation index is the measure in which it detects sensitivity of price. The price index is a normalised average of price relatives for a given class of goods or services. On the other hand, accumulation index is used as technical analysis indicator, which evaluates price and volume in the stock market.

Question 4:

a) Calculating the current price of each bond:

b) Calculating the duration of each bond:

c) Calculating price of the bond where market interest rates were to rise in 8%:

Question 5: Discussing and comparing the attributes that give IRR method its reliability and assess it capacity to price real options

            Internal Rate of Return method is mainly calculated by the organisation for detecting the level of expected return, which could be earned from the project. The internal rate of return is mainly calculated by the organisation to detect the level of income, which could be generated from an investment over its life. Internal rate of return is some times evaluated to be the yield in the investment, as it depicts the rate of return, which could be generated from a particular project. Therefore, managers use the internal rate of return method to detect the financial viability of the investment, while choosing the most viable investment scope (Bora 2015).

There are other investment appraisal methods, which could be used by organisations in detecting the financial viability of the prospect. However, internal rate of return allows the company to understand and compare different yield of the project with alternative life span and investments. In this context, Bornholt (2017) stated that organisation use internal rate of return, when net present value results does not provide a clear view for the investments. In addition, the organisations with the help of internal rate of return is able to detect the yield and thus compare it with the discount rate for detecting the financial viability of the project. This relevantly indicates that the company will only accept the project when the internal rate of return is higher that the hurdle rate of the organisation, as it intends to increase its firm value.

Question 3

            There are certain advantages in using the internal rate of return in accessing the real options presented to the organisation. The advantages of internal rate of return are depicted as follows.

Time Value of Money:

            The calculation to internal rate of return allows the organisation to compensate for the time value of money, as future cash flows are adequality evaluated in the formula. Companies using the method calculates the value of future inflows of the project with the actual initial investment, which needs to be conducted by the organisation. Hence, internal rate of return is calculated by detecting the return, which could be provided by project by evaluating the present value of future cash flows.

The main advantages of the calculation are that it uses time value of money to analyse the actual value of future cash flows by providing equal weight for cash flows and initial investment. Dhavale and Sarkis (2018) argued that internal rate of return ignores size of the investment and only focus on the return, which increases problem of the organisation during the initiation stage.

Simplicity:

            The second advantage of internal rate of return is its simplicity, which could allow the managers to take adequate investment decisions and detect the project with the higher rate of return from investment. Hence, small business owners or major organisations are able to get a snapshot of the investment scope, which is presented from the valuation. In addition, companies are also able to use the internal rate of return for the purpose of budgeting, which helps in making investment decisions such as to use new machine or repair the old one. The simplicity of the internal rate of return allows the managers to make investment decisions, which could support small and long business activities (Guerra, Magni and Stefanini 2014).

Hurdle rate not required:

            The calculation of internal rate of return does not need the hurdle rate or cost of capital or discounted rate of return for the calculation. However, the internal rate of return is used by the organisation to analyse the significance of the project and detect whether its value is higher than the hurdle rate. Hence, it could be understood that the internal rate of return calculation does not need the discounted or hurdle rate during the calculation process. In contrast, organisation use the output of internal rate of return calculation to detect the financial viability of the project and determine the best suitable investment option, which could increase their returns in future (Mellichamp 2017).

            Therefore, it could be understood that organisation use the internal rate of return from investment during the investment appraisal process to minimise the negative aspects of the NPV and other investment techniques. In addition, NPV and IRR is mainly considered by the managers, as it depicts the actual financial viability of an investment. Therefore, with the help of Internal rate of return organisations are able to assess projects capacity and detect the real options for investments.

References and Bibliography:

Arndt, C., Jones, S. and Tarp, F., 2016. What is the aggregate economic rate of return to foreign aid?. The World Bank Economic Review, 30(3), pp.446-474.

Bora, B., 2015. Comparison between net present value and internal rate of return. International Journal of Research in Finance and Marketing, 5(12), pp.61-71.

Bornholt, G., 2017. What is an Investment Project’s Implied Rate of Return?. Abacus, 53(4), pp.513-526.

Crosby, N., Devaney, S. and Wyatt, P., 2018. The implied internal rate of return in conventional residual valuations of development sites. Journal of Property Research, pp.1-18.

DeFusco, R.A., McLeavey, D.W., Pinto, J.E., Anson, M.J. and Runkle, D.E., 2015. Quantitative investment analysis. John Wiley & Sons.

Dhavale, D.G. and Sarkis, J., 2018. Stochastic internal rate of return on investments in sustainable assets generating carbon credits. Computers & Operations Research, 89, pp.324-336.

Guerra, M.L., Magni, C.A. and Stefanini, L., 2014. Interval and fuzzy Average Internal Rate of Return for investment appraisal. Fuzzy Sets and Systems, 257, pp.217-241.

Mellichamp, D.A., 2017. Internal rate of return: good and bad features, and a new way of interpreting the historic measure. Computers & Chemical Engineering, 106, pp.396-406.

Ng, E.H. and Beruvides, M.G., 2015. Multiple internal rate of return revisited: Frequency of occurrences. The Engineering Economist, 60(1), pp.75-87.

Ruslan, S.Z.M. and Jaffar, M.M., 2017, May. Application of numerical method in calculating the internal rate of return of joint venture investment using diminishing musyarakah model. In AIP Conference Proceedings (Vol. 1847, No. 1, p. 020007). AIP Publishing.

Santandrea, M., Sironi, A., Grassi, L. and Giorgino, M., 2017. Concentration risk and internal rate of return: Evidence from the infrastructure equity market. International Journal of Project Management, 35(3), pp.241-251.

Sim, T. and Wright, R.H., 2017. Stock Valuation Using the Dividend Discount Model: An Internal Rate of Return Approach. In Growing Presence of Real Options in Global Financial Markets (pp. 19-32). Emerald Publishing Limited.