Capital budgeting Question Solutions: YEAR 0 2 3 4 CF 000,000 $450,000 $350,000 $300,000 $250,000 COST OF CAPITAL = 8% NPV NPV = NPV = NPV = (416667 + 300068+238149+183757)- 1000000 NPV= $13,864. IRR Using trial and error: For 14%, + For 15%, + For 14.7%, + 1,000,000 Therefore: IRR= 14.7% Simple Payback YEAR 0 1 2 3 4 CF $ -1,000,000 $450,000 $350,000 $300,000 $250,000 CCF -1,000,000 -550,000 -200,000 -100,000 150,000 Payback period = A + B/C = 3 + 10,000 / 250,000 = 3.4 YEARS. NPV is theNETpresentvalue of post-tax cashflows less theinitialinvestment.
It shows the difference between the market value of the project and its cost. Aproject is onlyacceptableifthe NPV is more than zero. Since the NPV calculated $NPV= 13,864 is positive, itmeansthatthedecision is expected to addvalue to thecompany. NPV is a vividanddirectmeasure of howthisdecision will reachthesetobjective. Thismethod is themostcrucialalternative to NPV; itis mostlyutilized in practice. Itfocusesentirely on the approximated cashflows, anditdoesn’t depend on interestrates evidenced elsewhere.
Thevaluecalculated is IRR= 14.7%. Since thisvalue is above therequiredreturn, it has a positiveimpact on thisproject. Payback is thecount of events after which theinitialinvestmentcostis recovered. Theprimaryconcernemployed in the payback period is thetimetaken to gettheinitialamount of moneyback in a nominalsense? The value obtained in the calculations in this case was 3.4 years, which is less than thetargetperiod. Therefore, the payback period is acceptable. Investmentgains in thecompany can be measured by use of NPV, IRR or payback. Since cashflows that occur in thefuture of theprojects life are consideredmoreuncertain, thesetoolsprovide an indication of howcertaintheprojectcash inflows are.
In thiscase, theinvestmentcost will be recovered within the targeted periodthis is a significantgainforthe firm. In thisproject, of all the three methods, eachmethod has its level of impact on theproject. Themethod that would be mosteffective is NPV. Thisreason is that in thecalculation, after and before cashflowsare considered. Morealso, productivityandotherrisks are prioritized so as to maximize company’s worth. On otherside, themethod with theleasteffect is simple payback. Thisprocessis negatively biased on new and long-term investment projects (Campbell, Cheramy, & INTELECOM Intelligent Telecommunications (Firm), 2012). Outsourcing is the strategy where businesses move some of their functions from within the organisation to an outside provider of the service.
To successfully implement outsourcing, a lot of commitment is needed from top to down management and also a huge understanding of all the phases of outsourcing required. The benefits a business gains from the application of this strategy can be seen both from the operational and the strategic point of view. Businesses will normally go for outsourcing as a means of lowering the short-term direct costs (operational impact). Nevertheless, strategic outsourcing is capable of leading businesses to lower their long-term capital investments and leverage their key competencies significantly (strategic impact). Cost reduction motive: the outsourcer can experience lower logistics costs due to the increased efficiency of the work that the office duties will be handled by the outsourcing firm, this will lead to increased profits. Improved logistics service: improved delivery of services by the organisation can be as a result of benefits from the third party logistics provider’s increased levels of service consistency.
This enhances efficiency and can lead to higher customer satisfaction Capital budgeting is a decision-making process that involved the mangers making major decisions while investing in long-term assets such as land, buildings. Net present value is a significant capital budgeting method; it puts into considerations the present costs of a project against the present value of gains that a capital investment can generate during its economic life of the project.
This is basically subtraction of the present value of benefits from the present value of cost of a particular project. Present Value Cost is the initial cost of a capital investment. To get the Present Value Benefit, projected cash inflows of each year are multiplied the by a minimum rate of return at market rates, normally referred to as the cost of capital, for each year of the economic life of a fixed asset.
Add the Present Value Benefit of all the years and subtract the Present Value Cost from the sum to get the Net Present Value. Select the project with a positive Net Present Value for independent capital assets and one with the highest Net Present Value for mutually exclusive capital assets. Net present value takes into consideration the time value of money.
It is therefore more dependable than other investment appraisal methods which fail to discount future cash flows, an example being payback period and accounting rate of return. The accounting rate of return is a technique used to compare the expected profits from an investment with the total amount you needed for investment. With application of the method the average annual profit expected over the useful life of the investment project, is compared with the average amount of capital invested in the same project.
This is unlike other approaches of investment appraisal, the accounting rate of return is based on profits rather than cash-flow. So it is affected by subjective, non-cash items such as the rate of depreciation you use to calculate profits. The accounting rate of return also fails to take into account the timing of profits. References Campbell, C., Cheramy, S., & INTELECOM Intelligent Telecommunications (Firm). (2012). Capital budgeting. (Money flow. ) Pasadena, CA: INTELECOM.