Capital Budgeting: Decision Making For Printer Replacement

Initial Investment, operating cash flow, terminal cash flow

In the given report, a decision making needs to be done with respect to the capital budgeting. In the case study CQU printers is planningof replacing the old an existing printer with the new printer. 2 options have been given and all the relevant costs and revenue streams associated with it have also been highlighted. The life of both the replacement options Printer A and Printer B is given as 5 years and the company generally follows the straight line method of depreciation (Bromwich & Scapens, 2016). Several parameters have been given in the case study like the initial outflow, the book value at present and after 5 years and the salvage value, the sale value of the old machine which has been used in order to solve the sum and come out at the decision whether to replace the old printer or not and with which option. The company is already having the cost issues and also the quality compromise issues because of the old printer being used. The same will be solved when the printer is replaced and the new printer is installed with better efficiency and quality. The installation cost and the profit before depreciation for all the 5 years have also been mentioned to enable the decision making based on the cash flows and the capital gain tax has not been considered in the calculation.  

From the data set given in the question, following are the workings which have been made to work out the viability of the 2 proposed printers (Choy, 2018). The initial investment, the operating cash flow and the terminal cash flows have been shown below:

As per the data inputs given in the question, the relevant cash flow streams that can be derived out of the 2 proposed options have been given below. The same has been given considering that each of the option will be terminated at the end of the 5 years period.

Printer A: This can be sold at $ 400000 at the end of year 5 whereas the book value will be $ 43500. The profit then would be $ 356500 and out of which tax at the rate of 30% would have to be paid. The finaal cash flow would be $ 293050. Furthermore the working capital was also invested at the beginning. That would also be received back at the end of the period 5 and the amount will be $ 90400 (Alexander, 2016).

Cash flow streams at the end of 5 years

Printer B: In case Printer B is opted for in the beginning, the same can be sold at $ 330000 and the book value of the same at the end of year 5 would be $ 33000. Here also the tax would be 30% on the profits of $ 297000 post which the cahs flow to the company would be $ 240900. Since in this option no working capital is being invested in the beginning, therefore there is no cash flow with regards to the same.

Following are the detailed calculation for the payback period, net present value and the internal rate of return along with the explanation of the same:

1. Payback period: It is the period or the timeline within which the initially invested cash outflow can be recovered by the company in terms of the inflows(Belton, 2017). It basically shows the point of time when the company breaks even in terms of investment and from there on starts earning profit over and above the cost. It does not takes into account the cost of capital and the discounting factor, which gives the discounted payback period and is a far more better way to evaluating the capital budgeting decision as compared to the pay back period. The calculation for the given case study has been shown below:

Net present value (NPV): The net present value respresents the difference between the initial cash outflow and the cash inflows in the future discounted at required rate of return. Generally, the post tax profits are taken into consideration for evaluating anay decision. It is one of the most widely used technique in capital budgeting(Dichev, 2017). It takes into account the discounting factor based on the business’s required rate of return. In case the Net present value is more than or equal to 1 the proposal can be accepted or else it needs to be rejected. IN the given casse study, we can see from the table below, that the NPV is positive for Printer A whereas it is negative for Printer B. Therefore, it is viable to go ahead with Printer A.

Internal Rate of return (IRR): Internal rate of return is the rate at which the present value of the inflows is equal to the present value of the outflows. It is the rate at which the net present value is zero. It is again one of the best methods used in capital budgeting to evaluate the proposals. In case the IRR is above or equal to the required rate of return, the project should be accepted whereas in case if it is less than the required rate of return, the same should be rejected. In the given case study, the IRR of Printer A is 14.55% whereas the IRR of Printer B is 12.34%. This shows that Printer B has better return options(Linden & Freeman, 2017).

The graphical analysis of both the options and the results of the above analysis has been shown below in the form of charts.

The above graphical analysis is representative of the fact that Printer A beats Printer B in terms of all the 3 analysis, i.e., internal rate of return, net present value and payback period. Therefore, it is ideal for the company to opt for Printer A rather than Printer B (Farmer, 2018). 

Decision Techniques: Payback period, Net Present Value, Internal Rate of Return

The rankings of the two different replacement options as per the given 3 approaches is mentioned below via a table.

The above table shows that there is no conflict in the results as per all the 3 approaches. Printer A out does Printer B in all the 3 options. It is ranked 1 as per all the 3 options. Though the initial investment in Printer A is more than Printer B, but the same should be considered based on the quantum of returns in the future (Trieu, 2017). For taking any capital budgeting decision, first the NPV needs to be accessed and then the IRR and then any other alternatives which is available. In the given case, all the 3 are favourable in case of Printer A and hence, it should be selected.

1. Unlimited Funds: In case the company has unlimited funds it should opt for Printer A as it is feasible and viable in all the respects be it internal rate of return or the net present value or the payback period.
2. Capital Rationing: In case the company is facing the shortage of the funds and the funds allocation is being capped to a particular amount which is below Printer A, then the company has no other options but to buy Printer B in the presence of limited resources. Though the returns in Printer B is less than A, and the payback period is marginally more than Printer A, still the company can go ahead with it as no other options are left(Visinescu, Jones, & Sidorova, 2017). The only issue of concern here is the negative NPV.  

In case any situation arises as per which the cash flows or the returns associated with Printer A are said to be risky in comparison to the returns associated with Printer B, then the decision to invest or replace the old printer should be based on many other factors. Some of these include the standard deviation of the profit or returns of the printers, the NPV, the discounted pay back, etc. Also, we know that when the riskiness in any project increases, the returns should also increase simultaneously. Therfore, it needs to be seen that what is the annual return in the project (Sithole, Chandler, Abeysekera, & Paas, 2017). Prima facie, we can say that Printer A should be selected as all the evaluations are in favour of it even though the same is marked as risky.

In the given casse study, We know that CQU printers need to take a replacement decision with regards to the old printer. Several evaluation techniques and capital budgeting analysis has been done for the same and as per that, Printer A should be selected and it should be replacing old Printer. But, the final decision should always be based on the business requirement, the cash in hand, the  future inflows and outflows and finally whether or not there is any other option available like repairing the old Printer. 

Conclusion 

From the above analysis, it is concluded that Printer A should be replacing the old Printer B. It is the best alternative available with the company presently. However, in case the conditions like capital rationing is imposed or there is shortage of funds to invest, then the company should go ahead with Printer B. 

References 

Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 411-431.

Belton, P. (2017). Competitive Strategy: Creating and Sustaining Superior Performance. London: Macat International ltd.

Bromwich, M., & Scapens, R. (2016). Management Accounting Research: 25 years on. Management Accounting Research, 31, 1-9.

Choy, Y. K. (2018). Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, 145.

Dichev, I. (2017). On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), 617-632.

Farmer, Y. (2018). Ethical Decision Making and Reputation Management in Public Relations. Journal of Media Ethics, 1-12.

Linden, B., & Freeman, R. (2017). Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), 353-379.

Sithole, S., Chandler, P., Abeysekera, I., & Paas, F. (2017). Benefits of guided self-management of attention on learning accounting. Journal of Educational Psychology, 109(2), 220.

Trieu, V. (2017). Getting value from Business Intelligence systems: A review and research agenda. Decision Support Systems, 93, 111-124.

Visinescu, L., Jones, M., & Sidorova, A. (2017). Improving Decision Quality: The Role of Business Intelligence. Journal of Computer Information Systems, 57(1), 58-66.

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