NPV Analysis Of Implementing An Automatic Cutting Machine At Watley’s

NPV calculations

Capital budgeting is a process that is used by the financial am managers and the financial analyst to evaluate and determine the potential large expenses or investment opportunities of the business. the expenditure and the investment include long term project of the business such as building, new plant, long term venture etc. the capital budgeting method helps the business to evaluate all the factor and make decisions about accept or reject the proposal of the business on the basis of net profit, total time, return % etc (Schwartz, 2017).

In this report, the project proposal of Watley has been studied. Watley is planning to buy an automating cutting machine in order to reduce the additional expenses and improve the profitability position of the business. The net present value and other methods of capital budgeting has been applied to identify that whether the proposal should be accepted by the company or not. Along with that, the assumptions related to capital budgeting have also been studied.

NPV is one of the capital budgeting evaluation methods which evaluates the difference between the present value of cash outflows and inflows of a proposal or project (Lord, 2017). It evaluates the profitability position of a projected investment proposal or project. If the NPV of a project is positive then the project is a good option for the purpose of investment.

In case of Wately, the project of the business has been evaluated and the below results have been found:

(Weetman, 2013)

The above table of NPV represents that the total net cash inflow of the company is quite higher than the total cash outflow of the business which represents that if the automatic machinery would be implemented by the business than the total cash inflow of the business would be higher than the cash outflow of the business which depicts that the project is better option to switch. And it must be accepted by the business.

As stated in the question, capital budgeting analysis requires various assumptions in order to reach over a conclusion about the acceptance or reject of a proposal. Capital budgeting theory mainly assumes that the main goal of the stakeholder’s of an organization is to take full advantage of the total value of the firm. In addition, it is also assumed by the business that the business could access to the perfect financial market which allows the company to finance all the value enhancing projects (Kaplan and Atkinson, 2015). When all of these assumptions are met, an organization could separate the investment decision and financing decision. And the business must invest in all the projects which are offering the positive present value.

In the case of Watley, the below assumptions have been made in order to take decision about the acceptance of automatic cutting machine:

1. Maximize the shareholder worth:

It is the main assumption of the capital budgeting methods. the capital budgeting methods are applied by the financial analyst to evaluate the better project which would improve the profitability level of the business and along with that, the performance of the company would also be improved which ultimately lead to the business and the shareholders towards the better worth (Higgins, 2012).

Assumptions

In this case, along with the study over the profitability level of the business, Watley has also make sure that the new project has offer a base to the company where the shareholder’s worth of the business could be improved and it becomes easier for the shareholders to improve the overall performance of the business.

1. Management resources:

Further, the other assumption of a business and the capital budgeting methods is to manage the total resources of the business so that the main goal of the business “maximum utilization of minim resources” could be achieved (Drury, 2015). The capital budgeting methods are applied by the financial analyst in order to maintain a position where the available resources of the business could be utilized at their fullest. As the case explains that after implementing the automatic cutting machine, the annual savings in the labour cost would be improved as well as the efficiency and profitability level of the business would also be improved.

In this case, along with the study over the profitability level of the business, Watley has also make sure that after implementing the automatic cutting machine, the annual savings in the labour cost would be improved as well as the efficiency and profitability level of the business would also be improved. Thus, the project should be accepted by the business as it would offer a great base to the business.  

Other capital budgeting methods:

The capital budgeting study represents that there are various methods to measure that whether the project should be accepted by the business or not. In order to compare the decision of the capital budgeting, other capital budgeting methods have also been applied:

Discounted payback period:

It is also one of the capital budgeting methods. Discounted payback period explains that in how much time, the total investment would be got back by the business. On the basis of the below table, it has been found that the total investment would be got back by Watley in 3.62 years which is lower than the total time period and so the project must be accepted by the business (Garrison, Noreen, Brewer and McGowan, 2010).

 
Payback period:

Payback period is also known as one of the capital budgeting techniques which explains that in how much time, the total investment would be got back by the business. On the basis of the below table, it has been found that the total investment would be got back by Watley in 3 years which is lower than the total time period and so, it is recommended to the business to accept the proposal.

(Damodaran, 2011)

Internal rate of return:

Further, internal rate of return is also a capital budgeting technique which depicts about the profitability position of a project. It is a discount rate which explains that at what rate, the NPV of the project would be zero. On the basis of the below table, it has been found that the internal rate of return would be 12.59% whereas the cost of capital of the business is 10%. It explains that the internal rate of return is better of the project and thus it must be accepted by the business (Gitman and Zutter, 2012).

(Brigham and Ehrhardt, 2013)

Profitability index:

Lastly, profitability index has been applied on the project. It is also a capital budgeting technique which is used by the financial analyst to identify the relationship among the cost and benefits of the proposed project. A profitability index must be higher than 1.0 as it defines the position where present value of the business is higher than the initial investment of the business (Davies and Crawford, 2011). On the basis of the below table, it has been found that the profitability index of the project is 1.33 which is higher than 1.0. It explains that the proposal must be accepted by the business because of the present value of cash inflows of the business are higher than the initial investment of the business.

(Atrill and McLaney, 2015)

On the basis of the study over all of these methods, it has been found that all the methods are recommending the company to accept the proposal as the proposal would offer positive return to the company. Along with that, the IRR of the project is also advanced than the total cost of Watley limited, investment could also be got back in lesser period which indicates that all the methods are supporting the recommendation of NPV and thus the project must be accepted in the business (Brigham and Michael, 2013).

Conclusion:

Through conducting the study over the NPV, assumptions of capital budgeting and the various other methods of capital budgeting, it has been found that the project would perform better in the market. The profitability level of the project is advanced than the previous machineries of the Wately limited. As well as, the assumptions depict that the proposal would help the business to advance the general performance in the entire industry and marketplace. It also defines that the in IRR of the project is also advanced than the total cost of Watley limited, investment could also be got back in lesser period which indicates that all the methods are supporting the recommendation of NPV and thus the Watley limited is recommended to invest in the machineries.

References:

Atrill, P. and McLaney, E. 2015. Accounting and Finance for Non-Specialists (9th Ed). Harlow: Pearson Education.

Brigham, E.F. and Ehrhardt, M.C., 2013. Financial management: Theory & practice. Cengage Learning.

Brigham, F., and Michael C. 2013. Financial management: Theory & practice. Cengage Learning.

Damodaran, A. 2011. Applied corporate finance. John Wiley & sons.

Davies, T. and Crawford, I., 2011. Business accounting and finance. Pearson.

Drury, C. 2015. Management cost accounting. Cengage Learning.

Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial accounting. Issues in Accounting Education, 25(4), pp.792-793.

Gitman, L.J. and Zutter, C.J., 2012. Principles of managerial finance. Prentice Hall.

Higgins, R. C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.

Lord, B.R., 2007. Strategic management accounting. Issues in Management Accounting, 3.

Schwartz, M.S., 2017. Corporate social responsibility. Routledge.

Weetman, P. 2013. Financial and management accounting: An introduction. Pearson.

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