Cid1251 Finance And Management : Assessment Answers

Answer:

Introduction:

The current case study concentrates on business decision of Needles Manufacturing to consider replacement of one of the machines of the firm that can be utilized for manufacturing toys in the factory. As a manager of the firm, it is important to participate in the business decision and participate in the process of elaborate discussion with other members of the senior management regarding the proposed decisions. As per the current case, there are essentially three different alternatives, straight replacement of the present machine with Alpha Machine, selection of Beat machine from a German supplier and the Camn machine from the USA.

The management of the firm can utilize different investment appraisal techniques such as NPV (Net Present Value), IRR (Internal Rate of Return) and the Payback Period (Gitman et al. 2015). There are different factors that needs to be taken into consideration before arriving at the investment decisions are the amount of capital, cost of capital, entire life of the project, cash flow from the project, capital allowances as well as taxation, grants and the residual value of the definite asset.

Assessment of the alternative proposals using three different appraisal techniques for evaluation of capital investment decisions

As rightly indicated by Titman and Martin (2014), Net present value can be considered as a capital investment appraisal mechanism that can enumerate the overall inflow of cash both shortfall and excess only after the daily finance obligations are met. Again, internal rate of return (IRR) is also an effective investment appraisal technique that can be used for describing IRR as necessarily a discount rate that can lead to zero value to the particular NPV. Furthermore, another capital investment appraisal mechanism that cab be considered based on the time that can be taken for getting back the initial investment can be regarded as the payback period (Besley and Brigham 2013).

Comparison of the inflows as well as outflows for each machine under each method

Objective of Net Present Value (NPV)

The objective of NPV is to enumerate different ways in which investors can determine the extent of attractiveness of diverse potential investment. Thus, the primary intention and purpose of the investment appraisal technique is to determine the overall present value of necessarily the gain or else loss of an investment. As rightly put forward by Tricker and Tricker (2015), positive NPV adds value to the entire corporation, whereas negative NPV leads to subtraction of value. As a result, it can be said that it is not recommended to undertake projects having negative NPV. In particular, as long as different alternatives are discounted to a particular point in time, NPV has the objective to allow for simple comparison between different investments alternatives (Bezzina et al. 2014). Thus, investor needs to undertake investment that has higher NPV. Again, NPV can be regarded as the discount rate that again can be customised for reflecting different factors for example risk present in the market.

Internal rate of return (IRR) also simply referred to as the minimum rate of discount that the management utilizes in order to detect the capital investments or else future projects that can yield an acceptable return. Swift (2015) suggests that the IRR for a particular project is rate that can equate the net present value of future cash flow from a prospective project to zero. The IRR formula can be enumerated by equating the entire sum of present value of the definite cash flow of the future period less than the first investment to zero. The formula for enumeration of IRR is therefore as follows:

0 = P₀+P₁/ (1+IRR) +P₂/ (1+IRR) ^2+P₃ (1+IRR) ^3+………..+P_n/ (1+IRR) ^n

Here, P_0, P₁,…………….,P_n essentially equals the total flows of cash during the period 1,2,3……n, respectively and the IRR equates the internal rate of return of the project.

(Refer to appendix for the calculation of the IRR for the three different machines that can under consideration)

Objective of IRR

The primary objective of Internal Rate of Return (IRR) is to analyse investments, capital acquisitions, proposals for project, programs as well as business case scenarios. In particular, the objective of IRR technique is takes into account specific “investment view” of anticipated financial outcomes (Swift 2015).

Here, NPV and IRR has been calculated for the three different machines as shown below:

Objective of Payback Period

The objective of the payback period is to act as a tool for evaluation that can be utilized for investment appraisal. This is because it is simple to implement and understand for majority of individuals, irrespective of academic training or else ground of attempt (Weygandt et al. 2015).

Advantages and disadvantages of each of the methods

Advantage and disadvantage of NPV:

• The obvious benefits of the net present value mechanism is that it takes into consideration certain fundamental idea that worth of a future dollar is less than value of a dollar today.
• In addition to this, the NPV method also mentions that investment can generate value for the business organization or else the investor and to what extent especially in terms of dollars.
• Another advantage of NPV is to take into account particular cost of capital as well as risk inherent in making forecasts concerning the future (Beed 2016).

Disadvantages of NPV:

• As rightly indicated by Petty et al.(2015), one of the biggest disadvantages of the investment appraisal technique NPV is that it calls for the need of estimation of cost of capital of the business concern. As such, the assumption of the cost of capital can lead to sub optimal investments.
• In addition to this, the method of NPV is also not effective for comparison between the two different projects that are necessarily of varied size. In itself, the size of specifically the net present value output can be determined by size of the employed input (Ardestani et al. 2013)

Advantage of the IRR:

• Advantages of the internal rate of return includes the evaluation of investment proposals considering time value of money
• It is simple to analyse and visualize by different managers (Beed 2016)
• In case of IRR, it is not necessary to decipher hurdle rate or else the required rate of return for ascertainment of IRR.

Disadvantages of IRR:

• IRR method essentially ignores definite dollar value of the acquired benefits.
• This method implicitly assumes unreasonable and implied supposition of reinvestment rate(Beed 2016)
• IRR presents a percentage interpretation value that is not adequate

Advantage of Payback Period:

• Payback period can be considered to be simple and at the same time easy to understand
• Payback period also is comprehensively utilized and easy to understand (Titman and Martin 2014)
• Payback period provides more emphasis on liquidity for arriving at decisions regarding investment proposals
• Payback period essentially manages business risks. However, the project with the shortest payback period can be considered to be relatively less risky than the project with the longest payback period (Titman and Martin 2014)
• Short term mechanism of payback period can be regarded as a supplementary benefit of enumeration of capital expenditure

Disadvantages of Payback Period:

• In case of payback period, the time value of money is not detected
• Payback period provides greater importance on liquidity and disregards profitability
• Flow of cash before the payback period is taken into consideration. Flow of cash occurring after the payback period is not taken into consideration (Ardestani et al. 2013).

Calculation of NPV, IRR and Payback Period compared to cash flows