Financial Management Sample for Students

Feasibility of project using various investment appraisal techniques.

Payback Period

Payback period means the time taken by the investment to recover its initial cost. It is also defined as the period within which investment will reach point of its break even. Investment's desirability is related directly with the payback periods. Shorter the period more profitable is the investment for company. It is used by managers and investors for making quick decisions for investments. The concept is used mainly in capital and financial budgeting. It is also used for determining the cost saved from energy efficient technologies. Financial management is concerned with evaluating the values of different investment technique. Most of the appraisal techniques take into account time value of money. That gives the analysts the worth of money that will be generated by company in future (Awojobi and Jenkins, 2016). Time value is taken into account for having the concerns related to the opportunity cost. But payback period disregard the concept of time value.

Calculations for payback period

Working Notes :

Initial investment = 275000

Cash flow = Inflow- outflow

= 85000-12500

= 72500

Payback period = 275000/72500

= 3.9 years.

Recommendations

Payback period of the machine show that the initial cost will be recovered in 3 years 9 months. Seeing the cost of machine the time period is not very high in which the costs are recovered. Though the time period is not very short but the costs will be covered before the useful life of the machine. Since the cash flows will recover the costs of machine it could be said that the investments is attractive and should be adopted by the company. Break even point is reached by company so the company will generate generate profits after covering the cost.

Accounting Rate of Return

It is return expected from the investments or project in percentage terms. It divides revenues average from the project by the initial investment made for deriving the ration which is expected from the assets over its life time. The concept does not takes into account time value of money that is an integral part of the business. It is another technique used in capital budgeting for checking the profitability of investment. It is mainly used for making comparisons between more than two projects. It factors for the expense of depreciation associated with assets. Depreciation is an accounting process that is required to be considered in the feasibility of asset (Ogunbayo and et.al., 2019). It is used by experts to assess whether the returns from investments are adequate or not.

Calculations for ARR

Depreciation = Cost of assets - Scrap value / Life of machinery

Depreciation = 233750 / 6

= 33958.33

Net Cash Flows

Recommendations

Accounting rate of return shows that the company should make investments for the machine. The statement is based on the accounting rate calculated by the expert for the given machine project. Machine is costing 275000 with the useful life of 6 years. During he useful life it it will be generating adequate rate of return that will be providing company with enough cash flows to recover the cost of investment and with profits on time. Every company makes investment for increasing the profitability and having a sustainable growth. It is essential for the business enterprise to ensure that the return is adequate. Project should be accepted by the company based on the results generated by the accounting return as the return of 12.19% is appropriate as per the other projects of industry.Order assignment help from our experts!

Net Present Value

NPV is the present worth of money that will be flowing to company from an investment or project over its entire life. It is a type of intrinsic valuations that are used extensively in financing and accounting decisions by the company. It is important for determining the values of investments, projects and business involving the cash flows. It is an investments appraisals technique highly used by organisations for determining the feasibility of investments. It is all encompassing metrics as all the expenses, revenues and the capital cost related with investments are considered in its cash flows. The cash flows are discounted by the cost of capital associated with the project (Warren and Seal, 2018). The profitability of the investments is identified using this technique project is considered profitable if the net present value left after recovering initial investment costs is positive.

Recommendations

The NPV of the project is positive and is valued at 43976. The project seems to be feasible from this approach of capital budgeting. Positive NPV represents that the project will be profitable for the company and should be adopted. It represent that the present value after discounting the future cash flows is coming to 318976 during the useful life of asset where the cost of machine is 275000. This shows that project will generate profits after considering its initial cost of the investments. The method has considered the residual value of machine in its cash flows. This approach also recommends for accepting the machine and should be installed for manufacturing the food products. The cash flows have been discounted taking cost of capital of 12% as the discounting rate.

Internal Rate of Return

It is a discount rate which makes Net present value of the project to zero. It is also referred as the expected compounded annual rate of return from the project or investment. The project is considered profitable if the rate of return on investment is high (Elmassri, Harris and Carter, 2016). It could also defined as growth rate expected from an investments.

Calculations for IRR

IRR = Lower discounted rate + NPV at lower discount rate NPV at lower discount rate- NPV at higher discount rate) * Higher discount rate- lower discount rate

Working notes:

Net present value @ 12%

Net present value = 297828-275000

= £22828

Net present value @ 18%.

Net present value = 253576-275000

= -£21424

Recommendations

The IRR from the project will be 15.07 % or 15% approx. This shows that the project will b generating enough returns to cover the cost along with the profits. The rate is high and it could be said that the project should be accepted by company.

Advantages and dis-advantages of investment appraisals techniques

Payback period

Advantages

• Projects are ranked on the basis of merits.
• It is considerably simple and easy method to calculate.
• The method proves to be more useful when the project involves uncertainty.

Dis-advantages

• The method overlooks cost of capital or the interest factor that is important in decision making.'
• It does not have any rational basis to determine acceptable minimum pay back period.

Accounting Rate of Return

Advantages

• ARR is straightforward and simple to compute.
• It focuses over accounting the net operating income (Awojobi and Jenkins, 2016).
• It also allows comparison of new project with that of the reducing one.
• Accounting rate of return is also used for evaluation he performance of management.

Dis-advantages

• Concept of time of money is ignored by this technique.
• Rate of return does not remains constant during the useful life of assets.

Net Present Value

• NPV takes into account the time value of money.
• This tools accepts patterns of conventional cash flow.
• Discounting rates considers the factors of risks.

Dis-advantages

• It is difficult to determine the opportunity cost or the rate at which project will be discounted.
• Higher NPV of short term projects may not boost the return over equity of company.

IRR

Advantages

• The tool considers the time value even when cash flows are uneven or even.
• It is considers profitability of investment throughout the economic life of project that helps in evaluating true profitability of project.
• Pre determinations of cost of capital is not required (Udoudo, 2017).Order Dissertation Help from our experts!

Dis-advantages

• The concept involves tedious calculations for IRR.
• It focuses only over profitably and not on recouping the capital expenditures.

CONCLUSION

The project's positive NPV of $43,976 concludes that it is feasible and has the potential to be profitable. The project promises continued profitability with a present value of $318,976 during the asset's useful life compared to an initial cost of $275,000. Additionally, this technique highly advises adopting and installing the machine for the production of food products when taking into account the residual machine value in cash flows. Using a discount rate of 12%, this choice is both favourable and sound from a financial standpoint.

Read also -Applied Corporate Strategy for Business

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