516 Accounting: Business Reporting for Decision Making
• The IRR is the rate of return that discounts the cash flows of a project so that the PV of the cash
inflows equals the PV of the cash outflows, or the difference between the PV of the cash inflows and
the PV of the cash outflows is zero.
• The equation used to find the IRR is similar to the NPV equation, except that the value of the
equation is set to zero when finding the IRR.12.6 Practical issues in making decisions
LEARNING OBJECTIVE 12.6 Explain some of the practical issues in making investment decisions.
The tools outlined earlier in this chapter make decision making appear relatively easy. Just crunch the
numbers and there is your answer! However, many things are seldom as easy as they appear. In practice,
the investment decision is not normally just a mechanical calculation. There are many other factors that
must be taken into consideration. We have already discussed the impact of inflation, risk and opportunity
cost. In addition, many decisions and judgements must be made about:
- collecting data
- taxation effects
- finance
- human resources
- goodwill and future opportunities
- social responsibility and care of the natural environment.
Collecting data
Collecting data on costs and returns is often not easy. Think back to the Coconut Plantations’ rela-
tively simple coconut oil equipment investment project. In that case, finding the cost of the equipment
is simple. Moreover, some of the periodic outflows — such as equipment maintenance and insurance —
are relatively easy to cost, but others are not.
The quantity of electricity for running the plant to manufacture the coconut oil, for example, and its
total cost are difficult to estimate. There could be unforeseen issues such as poor-quality ingredients that
require additional processing to get to the desired end product — certified organic coconut oil! But what
about the returns? In order to estimate the cash inflows each year, the manufacturer needs to think about
the cost of the ingredients in the process. Ingredients such as unprocessed coconut will fluctuate in price.
So, you can see from this simple example that collecting data is not as easy as it looks.
Taxation effects
Taxation impacts on investments. Most, if not all, developed countries have some form of income tax,
and many have a form of capital gains tax. Australia is no exception, with a 30 per cent flat company
tax rate, and marginal taxation rates of up to 46.5 per cent plus a 1 per cent Medicare levy surcharge
for businesspeople and investors operating as individuals and in partnerships. Capital gains are taxed at
30 per cent for companies and, under the simplest current regime, at half marginal rates for individuals
and investors operating in partnerships. Thus, the impact of taxation for a simple investment by a com-
pany is to reduce net cash annual returns by 30 per cent. Complications are introduced into cash-flow
analyses with the effect of taxation benefits that stem from non-cash costs such as depreciation.
Moreover, in Australia the issue of taxation is even more complicated. Australia has the dividend impu-
tation scheme, where investors in companies that pay income tax are allowed tax credits for the dividends
that they receive out of company profits on which taxation has been paid. This scheme was introduced to
reform the system of double taxation that had been in place. The effect of dividend imputation in relation
to PV analysis of investments is that taxation is treated differently according to the legal structures of the
entities involved. For example, companies fully owned by resident Australian taxpayers should not include
income taxation effects in their investment appraisals, while sole traders and partners should.
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