Table of Contents
2.0 Calculation of Payback Period.
2.1 Project 1- Motor Software Project
2.2 Project 2- Hardware Project
3.0 Calculation of NPV.
3.1 Project A- Motor Software Project
3.2 Project 2- Hardware Project
4.0 Justification of final calculations and concluding decision-making procedure.
4.1 Impacts of Payback period and NPV on two given projects.
4.2 Impacts of financial and non-financial factors.
5.0 Practical implication.
Capital budgeting is an important term in business decision-making statements. The capital budgeting method follows a number of analysis that involves various projects which benefits a particular organization (Ryan and Ryan, 2002). According to Atrill and McLaney (2017), capital budgeting is a method that includes a company’s major decision-making system. They also indicated that these decisions are followed up with calculations, evolutions and mostly with ranking numerous projects which will be responsible for the company’s increasing financial values. The aim of this research paper is to study the extent of using capital budgeting techniques on choosing a suitable project for investment. Firstly, the paper will continue to calculate the payback period and the net present value of the two different projects given. Moreover, the paper will also indicate the advantages and disadvantages of the followed-up methods with practical ideas.
2.0 Calculation of Payback Period and NPV
2.1 Calculation of Payback Period
The payback period (PBP) is a common technique that evaluates the investment of capital budgeting of a company (Al-Ani, 2015). Broadbent and Cullen (2016) stated PBP as a formula that includes initial investment which is separated by the average cash inflows yearly. According to them valuable projects mostly have lower PBP. The following is the calculations of both the projects given in the task:
Project A-Software Project
|Year||Cash flows (£)||Balance (£)|
From the calculation of project A’s PBP, it has been found that the beginning investment will be recovered within.
Project B- Launderette Project
= 3 years and 1.5 months
2.2 Calculation of NPV
Net Present Value (NPV) is one of the best procedures for long-term investment. This method outputs calculations of the permissibility of the projects (Arshad, 2012). The method shows how an investment project influences company shareholders’ finance in present value terms (Jory et al. 2016). The technique identifies projects having less NPV and rejects those.
Project A-Software Project
|Discount factors (11%)||Present valuev d
|Net present value||£159296 – £100,000
From the calculation of project A’s NPV, it has been found that the project value is positive and increased the shareholders’ wealth by £59296.
Project B- Laundrette Project
|Discount factors (11%)||Present value
|Net present value||£185173– £120,000
This paper results in the positive NPV records in both of the projects given with values of £59296 and £65173. Therefore, both of these projects are accepted without any doubt. According to Jory et al. (2016), projects with positive NPV are wealth enhancing these projects have great importance in accomplishing the goals of management.
4.0 Evaluating and analyzing the calculated results and making the final decision
4.1 Effectiveness of Payback Period and NPV in case of XYZ plc investment project
PBP is a very easy technique of capital budgeting and it enables the manager to measure the risk of investment quite easily. Measuring the time period that will take for a company to recover the cost of investment can identify the good projects (Al-Ani, 2015). Compact firms are the most appropriate for use of the PBP. Rees (2015) claimed that an ideal way of eliminating the risk of a project is through the use of PBP. However, there happen to be some demerits of this technique and one of them is ignoring the implication of value of finance and all cash flows. The following projects: project A and project B having low PBP of 3 years and 1.09 months and 3 years and 1.5 months indicate that both of them are accepted but project B is more accurate in terms of mutually exclusive since it has a lower period of recovering initial cost.
On the other hand, Net present value (NPV) is the sum of all project cash outflows and inflows, each being discounted back to present value. The method is considered for revenues minus costs since it discounts the cash inflows using a cost of capital rate (Rees, 2015). A firm gets maximum value when they use the NPV calculation relying on the time value of money as it identifies the number of cash returns. Seemingly, NVP has some demerits as well. One of these demerits is its chaotic calculation system with the need for a good amount of understanding of calculating the cost of capital. NPV method is used with uncertainty since it does not give any accurate results for the future rather gives approximate results (Knight, 2015). The given project A has an NPV of £59296and B has £65173. Therefore, both of them are accepted. But one thing is that Project A needs only £100,000 as an initial investment but B requires £120,000. The firm will therefore accept project A over project B if they have a capital rationing problem.
4.2 Implication of financial and non-financial factors on stakeholders and decision-making process
A company’s financial factors include the costs of the company and it also indicates the capability of handling selected projects chosen for long time investment. However, non-financial factors such as taking financial decisions are also responsible for bringing a company’s increasing value from financial investment. Both the payback period method and NPV are being used for long-term investments projects. Both of these techniques allow analyzing the practicability of the investment. When an investment project is taken at time zero and portraits results of a good amount of value that is greater than the cost of investing, it becomes easier to choose that type of project. These evaluation systems are mostly based on accounting information and cash flow-based criteria (Adler, 2000). Managers tend to look after these financial factors while taking major financial decisions.
The company managers firstly identify the initial investment in a project and calculate the expected amount of cash return, various intervals and required rate of return for capital. If the project shows positive outcomes, it gets accepted since the net present value show more value than the project’s initial cost. This technique of NPV claims the value of an investment in amount (Arshad, 2012). These data of financial statement results help the managers to make decisions for selecting long-term investment projects. While taking decisions according to PBP analysis results the managers consider the timing of cash flows of individual projects. Consequently, some non-financial factors such as culture, legislature and relationships among the workers, buyers and suppliers play vital roles in taking decisions for electing investment projects by the financial managers (Knight, 2015).
NVP and PBP methods are often useful in choosing the most accurate projects in order to bring out good outcomes from big investments. Even though, both methods have advantages and disadvantages it helps to elect the long-term investments for best results. However, on criteria, it seemed that the NPV method is followed mostly by the PBP method with positive reviews. The combination of both seems the most accurate for best results. To conclude, it can be claimed that this paper explained the influence of PBP and NPV methods on two different projects with results. The paper continued to identify the pros and cons of both methods with practical understanding. The result indicated that both methods are important in order to bring out the best results for an organization. The combination of both methods can help a business to run as profound as it needs,