Project A
The cash flows associated with the project for the period of coming 10 years is as follows(Alexander, 2016). All the costs and revenues have been considered in the same.
|
Inputs for the project |
|
|
Particulars |
Amount in $ |
|
Upfront cost |
3,000,000 |
|
Life of the plant (years) |
10 |
|
After tax scrap value |
200,000 |
|
Per year after tax profits |
700,000 |
|
Refurbishment cost at the end of 5th year |
2,000,000 |
|
Yearly cash flow from the project |
||
|
Years |
Cash Flow |
Cumulative Cash Flow |
|
0 |
(3,000,000) |
(3,000,000) |
|
1 |
700,000 |
(2,300,000) |
|
2 |
700,000 |
(1,600,000) |
|
3 |
700,000 |
(900,000) |
|
4 |
700,000 |
(200,000) |
|
5 |
(1,300,000) |
(1,500,000) |
|
6 |
700,000 |
(800,000) |
|
7 |
700,000 |
(100,000) |
|
8 |
700,000 |
600,000 |
|
9 |
700,000 |
1,300,000 |
|
10 |
900,000 |
2,200,000 |
|
Total |
|
2,200,000 |
The final net cash inflow from the given project is $ 2200000. This is before applying the discounting factors
In case 10% discount rate is being applied in the given case to evaluate the investments and the project, the net present value would be computed in the below mentioned way.
|
Capital Budgeting Project |
NPV |
||
|
Required Return = |
10% |
||
|
Year |
CF |
Formula |
Disc CFs |
|
0 |
(3,000,000.00) |
=(-3000000)/(1.1)^0 = |
(3,000,000.00) |
|
1 |
700,000.00 |
=(700000)/(1.1)^1 = |
636,363.64 |
|
2 |
700,000.00 |
=(700000)/(1.1)^2 = |
578,512.40 |
|
3 |
700,000.00 |
=(700000)/(1.1)^3 = |
525,920.36 |
|
4 |
700,000.00 |
=(700000)/(1.1)^4 = |
478,109.42 |
|
5 |
(1,300,000.00) |
=(-1300000)/(1.1)^5 = |
(807,197.72) |
|
6 |
700,000.00 |
=(700000)/(1.1)^6 = |
395,131.75 |
|
7 |
700,000.00 |
=(700000)/(1.1)^7 = |
359,210.68 |
|
8 |
700,000.00 |
=(700000)/(1.1)^8 = |
326,555.17 |
|
9 |
700,000.00 |
=(700000)/(1.1)^9 = |
296,868.33 |
|
10 |
900,000.00 |
=(900000)/(1.1)^10 = |
346,988.96 |
|
136,462.99 |
The NPV calculated above in the table indicates that the project creates value for the RWE enterprises Pty Limited. The NPV for the 10 year project is $ 136463, which is positive and hence the company should go ahead with the purchasing of the new production line (Chron, 2017).
The internal rate of return is one of the capital budgeting techniques being used by the companies to analyse whether to accept the project or not. It is the discount rate which makes the NPV of all the cash flows for the given project to be zero. It is the rate of discount at which the present value of the inflows is equal to the present value of the outflows. It relies on the same formula as NPV does and the word internal indicates that no external factors are being used like the cost of capital or the inflation factor(Bizfluent, 2017).
On the other hand, profitability index also known as the value investment ratio or the profit investment ratio may be defined as ratio of the present value of the future cash flows to the initial investment. It is very important capital budgeting tool that is being used in the ranking of the projects when there are several projects in hand out of which only few needs to be chosen. In short, it is value created per unit of investment (Bromwich & Scapens, 2016).
In case of RWE Enterprises the calculation of PI and IRR has been shown below:
|
Calculation of IRR and PI |
|
|
Years |
Cash Flow |
|
0 |
(3,000,000) |
|
1 |
700,000 |
|
2 |
700,000 |
|
3 |
700,000 |
|
4 |
700,000 |
|
5 |
(1,300,000) |
|
6 |
700,000 |
|
7 |
700,000 |
|
8 |
700,000 |
|
9 |
700,000 |
|
10 |
900,000 |
|
IRR |
11.05% |
|
Present value of inflows (a) |
3,136,463 |
|
Initial Investment (b) |
3,000,000 |
|
Profitability Index (a/b) |
1.05 |
The IRR is more than the discount rate i.e., 11.05% which indicates that the project is profitable. Furthermore, the profitability index of the project is also above 1, i.e., 1.05, therefore the project should be accepted (Farmer, 2018).
The payback period may be defined as the period or time taken by the project or investment to recover the initially invested amount in terms of savings or profits.
It is one of the capital budgeting techniques which is generally not being used as it ignores the time value of money as well as the cash flows beyond the cut off date. It gives biased results at times and can be thus deceiving (Dichev, 2017).
Project B
In case of RWE enterprises Pty Limited, the payback as shown in the below calculation is 7.14 years. Therefore, the company would be able to reciver its investments in 7.14 years and hence, the project should be accepted.
|
Yearly cash flow from the project |
|
||
|
Years |
Cash Flow |
Cumulative Cash Flow |
|
|
0 |
(3,000,000) |
(3,000,000) |
|
|
1 |
700,000 |
(2,300,000) |
|
|
2 |
700,000 |
(1,600,000) |
|
|
3 |
700,000 |
(900,000) |
|
|
4 |
700,000 |
(200,000) |
|
|
5 |
(1,300,000) |
(1,500,000) |
|
|
6 |
700,000 |
(800,000) |
|
|
7 |
700,000 |
(100,000) |
|
|
8 |
700,000 |
600,000 |
|
|
9 |
700,000 |
1,300,000 |
|
|
10 |
900,000 |
2,200,000 |
|
|
Total |
|
2,200,000 |
|
|
|
|||
|
Payback = Year 7 + (100000/700000) |
|
||
|
|
Payback = 7.14 years |
|
In the given case, Innovative Investments is proposing 2 projects for which the financial analysis has been shown below (Sithole, et al., 2017). The inputs from te hquestion has also been summarised in the below tables.
|
Inputs for the project |
||
|
Particulars |
Project A |
Project B |
|
Initial Outlay |
(275,000) |
(275,000) |
|
Year 1 |
50,000 |
100,000 |
|
Year 2 |
75,000 |
100,000 |
|
Year 3 |
100,000 |
100,000 |
|
Year 4 |
125,000 |
100,000 |
|
Year 5 |
175,000 |
100,000 |
|
Requirements for the project |
||
|
Particulars |
Project A |
Project B |
|
Required rate of return |
12% |
12% |
|
Payback Period |
<3 years |
<3 years |
|
NPV |
Positive |
Positive |
|
IRR |
> Firm’s discount rate |
> Firm’s discount rate |
- The payback period, Internal rate of return and the net present value calculation of each of the given 2 projects has been shown below(Félix, 2017):
|
Formula : Payback Period = Time period in which initial investment is recovered |
|||||
|
Particulars |
Year |
Yearly cash flows |
Cumulative cash flows |
||
|
Project A |
Project B |
Project A |
Project B |
||
|
Cost |
0 |
(275,000) |
(275,000) |
(275,000) |
(275,000) |
|
Cash Inflows |
1 |
50,000 |
100,000 |
(225,000) |
(175,000) |
|
2 |
75,000 |
100,000 |
(150,000) |
(75,000) |
|
|
3 |
100,000 |
100,000 |
(50,000) |
25,000 |
|
|
4 |
125,000 |
100,000 |
75,000 |
125,000 |
|
|
5 |
175,000 |
100,000 |
250,000 |
225,000 |
|
|
Payback period |
3.40 |
2.75 |
|
Formula : NPV = Sum total of PV of inflows – PV of outflows |
||||||
|
|
|
|
|
PV factor @ 12% |
PV @ 12% |
|
|
Particulars |
Year |
Project A |
Project B |
|
Project A |
Project B |
|
Cost |
0 |
(275,000) |
(275,000) |
1.0000 |
(275,000) |
(275,000) |
|
Cash Inflows |
1 |
50,000 |
100,000 |
0.8929 |
44,643 |
89,286 |
|
2 |
75,000 |
100,000 |
0.7972 |
59,790 |
79,719 |
|
|
3 |
100,000 |
100,000 |
0.7118 |
71,178 |
71,178 |
|
|
4 |
125,000 |
100,000 |
0.6355 |
79,440 |
63,552 |
|
|
5 |
175,000 |
100,000 |
0.5674 |
99,300 |
56,743 |
|
|
NPV |
79,350 |
85,478 |
||||
|
IRR : IRR is the rate at which PV of inflows is equal to the PV of outflows, i.e., NPV=0 |
||||||||
|
Check |
|
|
|
|||||
|
PV factor @ 20.97% |
PV factor @ 23.92% |
Present values |
||||||
|
Particulars |
Year |
Project A |
Project B |
|
1.2097 |
1.2392 |
Project X |
Project Y |
|
Cost |
0 |
(275,000) |
(275,000) |
1.0000 |
1.0000 |
(275,000) |
(275,000) |
|
|
Cash Inflows |
1 |
50,000 |
100,000 |
0.8267 |
0.8070 |
41,333 |
80,697 |
|
|
2 |
75,000 |
100,000 |
0.6834 |
0.6512 |
51,251 |
65,120 |
||
|
3 |
100,000 |
100,000 |
0.5649 |
0.5255 |
56,489 |
52,550 |
||
|
4 |
125,000 |
100,000 |
0.4670 |
0.4241 |
58,371 |
42,407 |
||
|
5 |
175,000 |
100,000 |
0.3860 |
0.3422 |
67,554 |
34,221 |
||
|
IRR |
20.97% |
23.92% |
|
NPV |
(2) |
(4) |
||
|
|
|
|
|
PV factor @ 12% |
PV @ 12% |
|
|
Particulars |
Year |
Project A |
Project B |
Project A |
Project B |
|
|
Cost |
0 |
(275,000) |
(275,000) |
1.0000 |
(275,000) |
(275,000) |
|
Cash Inflows |
1 |
50,000 |
100,000 |
0.8929 |
44,643 |
89,286 |
|
2 |
75,000 |
100,000 |
0.7972 |
59,790 |
79,719 |
|
|
3 |
100,000 |
100,000 |
0.7118 |
71,178 |
71,178 |
|
|
4 |
125,000 |
100,000 |
0.6355 |
79,440 |
63,552 |
|
|
5 |
175,000 |
100,000 |
0.5674 |
99,300 |
56,743 |
|
|
PV of inflows (A) |
354,350 |
360,478 |
||||
|
Initial Outflows (B) |
275,000 |
275,000 |
||||
|
Profitability Index (A/B) |
1.29 |
1.31 |
||||
|
|
|
|
- Based on the above results and assuming that both the projects are independent of each other and both could be accepted if viable and meets the given condition, following I steh table which shows the acceptability as per the given criterias in the question(Heminway, 2017).
|
Particulars |
Requirements for the project |
Acceptability of the project |
||
|
Project A |
Project B |
Project A |
Project B |
|
|
Payback Period |
<3 years |
<3 years |
No |
Yes |
|
NPV |
Positive |
Positive |
Yes |
Yes |
|
IRR |
> Firm’s discount rate |
> Firm’s discount rate |
Yes |
Yes |
From the above table it can be concluded that Project B meets all the given criteria of NPV, IRR and the payback period whereas Project A meets 2 of the criterias of NPV and IRR, missing out narrowly in payback period. Therefore, as per the above assessment, project B should be accepted and Project A should be rejected (Goldmann, 2016).
Based on the above assessment and results, the ranking sheet has been prepared for both the projects on the basis of each criteria and then the final ranking has also been given(Linden & Freeman, 2017).
|
Particulars |
Rankings for the project |
|
|
Project A |
Project B |
|
|
Payback Period |
Rank 2 |
Rank 1 |
|
NPV |
Rank 2 |
Rank 1 |
|
IRR |
Rank 2 |
Rank 1 |
|
Profitability Index |
Rank 2 |
Rank 1 |
|
Final Decision |
Rank 2 |
Rank 1 |
Therefore, given that the projects are mutually exclusive, Project B should be chosen and Project A should be rejected as it is failing to meet the criteria of Payback period (Jefferson, 2017)
References
Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp. 411-431.
Bizfluent, 2017. Advantages & Disadvantages of Internal Control. [Online]
Available at: https://bizfluent.com/info-8064250-advantages-disadvantages-internal-control.html
[Accessed 07 december 2017].
Bromwich, M. & Scapens, R., 2016. Management Accounting Research: 25 years on. Management Accounting Research, Volume 31, pp. 1-9.
Chron, 2017. five-common-features-internal-control-system-business. [Online]
Available at: https://smallbusiness.chron.com/five-common-features-internal-control-system-business-430.html
[Accessed 07 december 2017].
Dichev, I., 2017. On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), pp. 617-632.
Farmer, Y., 2018. Ethical Decision Making and Reputation Management in Public Relations. Journal of Media Ethics, pp. 1-12.
Félix, M., 2017. A study on the expected impact of IFRS 17 on the transparency of financial statements of insurance companies. MASTER THESIS, pp. 1-69.
Goldmann, K., 2016. Financial Liquidity and Profitability Management in Practice of Polish Business. Financial Environment and Business Development, Volume 4, pp. 103-112.
Heminway, J., 2017. Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents. SSRN, pp. 1-35.
Jefferson, M., 2017. Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland. Technological Forecasting and Social Change, pp. 353-354.
Linden, B. & Freeman, R., 2017. Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), pp. 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), p. 220
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
