Financial Investment Decision

This assignment discusses the importance of considering limitations when using investment appraisal techniques to evaluate projects. The average rate of return (ARR) method is highlighted as a flawed approach that prioritizes net profitability over cash flow, resulting in biased results. The conclusion emphasizes the need for investors to consider the sound financial position and performance of Next plc, as well as the potential benefits of investing in their business operations. Additionally, Hilltop Company is advised to invest in project A, which offers a higher return on investment. Furthermore, financial analysts are reminded to be aware of the limitations associated with each investment appraisal technique.

ACCOUNTING & FINANCE
FOR MANAGERS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
QUESTION 1...................................................................................................................................1
1. Analysis of financial and non-financial ratios of Next plc and Hennes & Mauritz..........1
2. Using charts for making comparison of two companies....................................................4
3. Recommendations for improvement in the performance...................................................7
4. Limitations of financial ratios............................................................................................8
QUESTION 2...................................................................................................................................9
1. Use of investment appraisal techniques.............................................................................9
2. Limitations of capital budgeting tools..............................................................................12
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................14

INTRODUCTION
Accounting and financial aspects are the main parts of a business organization which
plays a vital role in the growth and success of it. Finance manager of the firm has responsibility
to make effectual decisions which aid in the productivity and profitability of firm. In this,
investment appraisal techniques provide assistance to the firm in making suitable decisions.
Further, ratio is also the most effective financial tool through which investor can make most
profitable business decision. In the present report, financial and non-financial ratios of two
companies such as Next plc and Hennes & Mauritz will be analyzed. The main objective of this
report is to make assessment of the financial and non-financial aspects. It enables investors and
other stakeholders to make suitable investment decision. Besides this, report will also shed light
on investment appraisal techniques which assists Hilltop limited in making investment decisions.
QUESTION 1
1. Analysis of financial and non-financial ratios of Next plc and Hennes & Mauritz
Financial ratios include profitability, liquidity and efficiency ratios etc. which help in
analyzing the financial health and performance of the firm. Analysis of the financial ratios of
Next plc and Hennes and Mauritz are as follows:
Financial ratios: In this, financial statements of the firm area analyzed by the manager
with the help of profitability, liquidity, solvency and efficiency ratios. By this, company is able
to make comparison of its strategies which are employed them during the each accounting year.
In addition to this, it also facilitates comparison of the financial performance of one organization
with another one.
 Current ratio: This ratio represents the extent to which firm has sufficient amount of
current assets to meet the financial obligations. From ratio analysis, it has been
identifying that current ratio of the firm is continuously increasing. It is 1.28:1 on 2012
whereas it is 1.82:1 in the year of 2015. On the contrary to this, current ratio of Hennas &
Mauritz is 2.96:1 and it is 2.11:1 on 2014. Therefore, it can be stated that both the
companies are highly capable in relation to the meeting of its current obligations from the
current assets (Bogdan, Bareša and Ivanović, 2012).
Company 2014 2013 2012 2011 2010
1

Next plc 1.82 1.76 1.48 1.54 1.28
H&M 2.11 2.25 2.66 2.71 2.96
 Quick ratio: This ratio entails the level to which company can quickly convert its current
assets to meet the financial obligations. As compared to previous years quick ratio of
Next plc is 1.16:1 which shows decreasing trend. It shows that company is starting to
invest money in the other productive activities. Thus, it is one of the main cause due to
which current assets of the firm except stock and prepaid expenses are decreasing. In
addition to this, quick ratio of Hennes & Mauritz is 1.07:1 in the financial year 2014.
Acid test ratio of both the firms exceed ideal quick ratio which is .5:1. This aspect reflects
that both the companies have large amount of current assets which can be easily
convertible into cash (Goyenko, Holden and Trzcinka, 2009).
Company 2014 2013 2012 2011 2010
Next plc 1.16 1.18 0.97 0.91 0.72
H&M 1.07 1.22 1.49 1.69 2.06
 Debt-equity ratio: It provides information about the extent to which finance is raised by
the firm through debt and equity. Financial structure of Next plc shows continuously
fluctuating in the performance. Debt-equity ratio of Next plc lies between 2.31 to 2.96. In
the year of 2015, debt-equity ratio of the firm is 2.61:1. Thus, this ratio clearly shows that
company have fulfilled moreover, it financial needs from debt instruments rather than
equity.
Company 2014 2013 2012 2011 2010
Next plc 0.72 0.74 0.70 0.75 0.72
H&M - - - - -
Efficiency ratio: Asset, inventory and receivable turnover ratios are the measure which provides
deeper insight about the efficiency aspect of the firm. Turnover of the firm is highly associated
with the profit which is generated by the firm. It is one of the main causes due to which turnover
2

ratio is undertaken for the purpose of evaluation. These are ratio are highly significant which
helps hem in assessing the extent to which business success in generating sales from assets and
inventory. Besides this, receivable turnover ratio entails the information about the days for which
company needs to wait for collecting or getting the payment of credit sales. Through this,
company is able to make planning for the future more effectively and efficiently.
 Asset turnover ratio: This measure provides information about the sales which is
generated by the firm by making utilization of assets. During the financial period of 2011
to 2013 asset turnover ratio of Next plc is constant which is 1.89:1. In comparison to this,
asset turnover ratio of the firm is 1.81:1 in the accounting year of 2015. It represents that
in the year of 2014 and 2015 company fails to generate high amount of sales. On the
contrary to this, asset turnover ratio of Hennes & Mauritz is continuously increasing.
Thus, it can be said that strategic framework of Hennes & Mauritz is very sound.
Company 2014 2013 2012 2011 2010
Next plc 1.81 1.85 1.89 1.89 1.89
H&M 2.14 2.04 2.01 1.84 1.91
 Inventory turnover ratio: It reflects the number of times inventory is sold and used during
the year. Next plc inventory turnover ratio is 6.62:1 in the year of 2015. Whereas, in the
period of 2015 stock turnover ratio of Hennes & Mauritz is 3.46. On the basis of this
aspect, it can be assessed that Next plc have made of its inventory more effectively and
efficiently (Hays, DeLurgio and Gilbert, 2009).
Company 2014 2013 2012 2011 2010
Next plc 6.62 6.97 6.91 6.47 6.89
H&M 3.46 3.29 3.37 3.47 3.70
 Receivable turnover ratio: It provides deeper insight about the frequency in which
company receives payment from their debtors. This ratio of both the firms is declined
which reflects that companies are able to receive its payment within the less period.
Through this, companies are able to carry out its business operations more smoothly.
3

Company 2014 2013 2012 2011 2010
Next plc 5.45 5.56 5.72 5.97 6.14
H&M 33.12 33.16 32.42 29.64 32.92
Profitability ratio:
 Gross profit margin: This measure provides information about the profit which is
generated by the firm by making business expenses. Profitability aspect of Next plc is
continuously increasing but it is still very less from the GP ratio of Hennes & Mauritz.
Gross magin ratio of Next plc is between the ranges of 30% to 33%. In against to this,
profit margin of Hennes & Mauritz is continuous decreasing which is 58.81% in the year
of 2015. Higher profitability of Hennes & Mauritz reflects that sales planning or
strategies of the firm are better.
Company 2014 2013 2012 2011 2010
Next plc 33.59% 33.16% 31.48% 30.38% 29.27%
H&M 58.81% 59.13% 59.50% 60.13% 62.93%
 Net profit margin: Net profit ratio provides information about the profitability aspect of
the firm which it can use to distribute dividend to the shareholders. After tax or net
margin of Next plc is 15.87% and it is 13.19%. By making analysis of ratios it has been
identifying that Next plc makes their best efforts which in turn into the results of higher
profitability (Van and Kruidhof, 2013). On the contrary to this, net profit of the firm is
decreasing which is not good sign for the firm.
Company 2014 2013 2012 2011 2010
Next plc 15.87% 14.79% 14.34% 12.62% 11.93%
H&M 13.19% 13.30% 13.96% 14.38% 17.22%
Others:
 Return on equity: It represents the efficiency of firm in relation to the generation of sales
from shareholders equity. Next plc have earned 15.87% return by investing equities of
4

shareholders in the firm' operations. As compared to Next plc, return on equity of H & M
is 41.27%. This aspect of the firm shows that planning and business functioning of H &M
is sound in against to Next plc.
Company 2014 2013 2012 2011 2010
Next plc 208.75% 193.43% 200.12% 190.90% 214.98%
H&M 41.27% 38.38% 38.36% 35.84% 44.07%
 Operating cash flow: By making analysis of the operating cash flow of both the
companies it has been identifying that Asol ltd. needs to make investment in Next plc.
Moreover, operating cash flow of Next plc is higher which represents that company had
managed its cash related activities very efficiently in contrast to H & M.
Company 2014 2013 2012 2011 2010
Next plc 4.86 3.97 4.09 3.12 2.49
H&M 1.25 1.34 1.07 0.99 1.20
Summary of ranking financial
Basis Next plc H&M
Current ratio Worst Good
Quick ratio Worst Good
Debt-equity ratio Worst -
Asset turnover ratio Good Worst
Inventory turnover ratio Good Worst
Receivable turnover ratio Good Worst
Gross profit margin Worst Good
Net profit margin Good Worst
Return on equity Good Worst
5

Operating cash flow Good Worst
Limitations of financial ratios: Along with the advantages, there are several aspects
which restrict the significance of ratio analysis. Different companies prepare their financial
statements by taking into account different accounting principles or concepts. This aspect closely
influences the outcome of ratio analysis. For instance, a company undertakes accounting cost
concept whereas, competitor firm does not undertake such aspect. In this, it is quite difficult for
the finance manager to assess the efficiency aspect of firm in the right direction. In addition to
this, if both the companies operate in different business environment or countries then manager
of the firm is unable to make comparison of financial performance. Moreover, tax policies as
well as other rules and regulations highly differ from country to country. These aspects also have
significant impact upon the financial statement and performance of the firm. All these aspects
badly hamper the effectiveness of ratio analysis.
Non-financial ratio:
It consists of those which provide assistance to manager in assessing the extent to which
business is performing well. Manager of the firm can easily assess the growth and success of the
firm by making evaluation of the staff turnover ratio. Revenue and operating income is one of
the main factors which clearly provide information regarding the efficiency, ability and
satisfaction aspect of the personnel. With the help of such ratios company is able to make
planning for the future more effectively and efficiently.
 Revenue/ employees: It furnishes information about the sales made by the personnel.
With the help of this ratio, company can easily evaluate the skills and abilities of
personnel to a large extent. This ratio of Next plc is getting inclined from 114727 to
135729. Whereas, revenue generated by H & M through its employees is declined from
166639 to 138467. From this, it has been identifying that personnel of Next plc are highly
skilled and motivated as compared to H & M.
Company 2014 2013 2012 2011 2010
Next plc 135,729 130,916 125,360 119,962 114,727
H&M 138,467 147,942 156,151 159,858 166,639
6

 Operating income/employees: Employees earnings before interest and tax of Next plc are
continuously increasing which is positive sign for the firm. Further, operating income of
H & M is get decreased from 42580 to 28008. It reflects that human resources of Next plc
have made their great efforts and thereby make contribution in the growth and success of
firm.
Company 2014 2013 2012 2011 2010
Next plc 27,985 25,301 24,561 21,192 19,719
H&M 23,395 25,420 28,120 29,616 37878
 Brand Image – The brand image of Next PLC is positive in the retail industry. It comes
among the top positions of retail players. It is the largest clothing retailer in terms of
sales. The brand image is good among the customers as company supplies quality goods
and services. It is positive because financial health and performance of Next plc is good.
In addition to this, return on equity of Next Plc is continuously increasing which build
effective corporate image in the mind of shareholders. Further, company consistently
offer dividend to the shareholders which also develop positive image in the mind of
existing and potential investors. Company also makes repayment of loan within the
suitable time frame. All these aspect may result into effective brand image. Adaptability – Next plc holds a great strength of adaptability. This is very crucial in ever
evolving retail market. The strength of adaptability can be noticed in the delivery services
and home shopping networks. Efficiency ratios as well as return on equity and operating
cash flow increasing. On the basis of this aspect it can be stated that Next plc is able to
make modification in the strategic framework in accordance with the changing market
conditions.
On the basis all the above mentioned analysis it is suggested to the investors that they
needs to make investment in Next plc. Through this, investors are able to enhance its profitability
aspects.
Summary of ranking non-financial
Basis Next plc H&M
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Revenue/ employees Good Worst
Operating income/employees Good Worst
Particulars Ratios 2014 2013 2012 2011 2010
Financial ratios
Next plc Current Ratio 1.82 1.76 1.48 1.54 1.28
H & M Hennes &
Mauritz AB Current Ratio 2.11 2.25 2.66 2.71 2.96
Next plc Quick ratio 1.16 1.18 0.97 0.91 0.72
H & M Hennes &
Mauritz AB Quick ratio 1.07 1.22 1.49 1.69 2.06
Next plc Asset Turnover 1.81 1.85 1.89 1.89 1.89
H & M Hennes &
Mauritz AB Asset Turnover 2.14 2.04 2.01 1.84 1.91
Next plc Inventory Turnover 6.62 6.97 6.91 6.47 6.89
H & M Hennes &
Mauritz AB Inventory Turnover 3.46 3.29 3.37 3.47 3.7
Next plc
Receivable turnover
ratio 5.45 5.56 5.72 5.97 6.14
H & M Hennes &
Mauritz AB
Receivable turnover
ratio 33.12 33.16 32.42 29.64 32.92
8

Next plc Revenue/Employee 135729 130916 125360 119962 114727
H & M Hennes &
Mauritz AB Revenue/Employee 138467 147942 156151 159858 166639
Next plc Debt-equity ratio 0.72 0.74 0.70 0.75 0.72
Next plc COGS/Revenue 66.41% 66.84% 68.52% 69.62% 70.73%
H & M Hennes &
Mauritz AB COGS/Revenue 41.19% 40.87% 40.50% 39.87% 37.07%
Next plc Gross profit 33.59% 33.16% 31.48% 30.38% 29.27%
H & M Hennes &
Mauritz AB Gross profit 58.81% 59.13% 59.50% 60.13% 62.93%
Next plc Net profit 15.87% 14.79% 14.34% 12.62% 11.93%
H & M Hennes &
Mauritz AB Net profit 13.19% 13.30% 13.96% 14.38% 17.22%
Next plc Operating cash flow
208.75
%
193.43
%
200.12
%
190.90
%
214.98
%
H & M Hennes &
Mauritz AB Operating cash flow 41.27% 38.38% 38.36% 35.84% 44.07%
Next plc Return on equity
208.75
%
193.43
%
200.12
%
190.90
%
214.98
%
H & M Hennes &
Mauritz AB Return on equity 41.27% 38.38% 38.36% 35.84% 44.07%
Non-financial ratios
Next plc Revenue/employees 135,729 130,916 125,360 119,962 114,727
H & M Hennes &
Mauritz AB Revenue/employees 138,467 147,942 156,151 159,858 166,639
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Next plc
Operating
income/employees 27,985 25,301 24,561 21,192 19,719
H & M Hennes &
Mauritz AB
Operating
income/employees 23,395 25,420 28,120 29,616 37878
2. Using charts for making comparison of two companies
Current ratio and quick ratio of Next plc
Year Current ratio Quick ratio
2011 1.28 0.72
2012 1.54 0.91
2013 1.48 0.97
2014 1.76 1.18
2015 1.82 1.16
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1 2 3 4 5
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
1.28
1.54 1.48
1.76 1.82
0.72
0.91 0.97
1.18 1.16
Current and acid test ratio of H & M
Year Current ratio Quick ratio
2011 2.96 2.06
2012 2.71 1.69
2013 2.66 1.49
2014 2.25 1.22
2015 2.11 1.07
1 2 3 4 5
0
0.5
1
1.5
2
2.5
3
3.5
2.96
2.71 2.66
2.25 2.112.06
1.69
1.49
1.22 1.07
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Net profitability margin
Year Next plc H & M
2011 11.93 17.22
2012 12.62 14.38
2013 14.34 13.96
2014 14.79 13.3
2015 15.87 13.19
Net profitability of Next plc and H & M
Gross profitability ratio
Year Next plc H & M
2011 29.27 62.93
2012 30.38 60.13
2013 31.48 59.5
2014 33.16 59.13
2015 33.59 58.81
Gross profitability of Next plc and H & M
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Net operating cash flow
Year Next plc H & M
2011 208.75% 41.27%
2012 193.43% 38.38%
2013 200.12% 38.36%
2014 190.90% 35.84%
2015 214.98% 44.07%
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3. Recommendations for improvement in the performance
By doing ratio analysis it has been identifying that there are several areas on which Next
plc and H & M needs to make improvement are as follows:
Areas of improvement Next plc H&M
Current ratio Needs to improve Maintain
Quick ratio Needs to improve because it is Company needs to release its
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07/03/1905 07/04/1905 07/05/1905 07/06/1905 07/07/1905
0
0.5
1
1.5
2
2.5
Next plc
H & M

higher than the ideal ratio. assets in the further productive
purpose.
Debt-equity ratio Needs to make modification in
the existing financial structure.
-
Asset turnover ratio Maintain Effective action or measures
are required for the
improvement.
Inventory turnover ratio Strengthened Company needs to improve its
inventory turnover.
Receivable turnover ratio Maintain Business unit needs to make
improvement in receivable
turnover.
Gross profit margin Improved as compared to
before.
Needs to make improvement
due to decreasing trend.
Net profit margin Needs to be strengthened. Improvement is required to
prevent the decreasing trend.
Return on equity - Improvement is required
Operating cash flow - Needs to improve
Recommendations for Next plc
 From the outcome of ratio analysis it is suggested to Next plc that they needs to employ
their current assets in the other productive activities rather than keeping it with itself. By
this, company is able to enhance its productivity and profitability aspect.
 Further, Next plc have fulfilled more of its financial needs from debt instruments rather
than equity. Thus, manager of the firm is required to make balance in their financial
structure. On the basis of this aspect business needs to take financial assistance from
equity aspect which proves to more fruitful for the firm. In addition to this, organization is required to frame competent strategies and policies
which facilitate optimum utilization of assets and inventory to the large extent. Thus,
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business unit needs to encourage their personnel to make their best efforts in the growth
and development of firm. For this purpose, company needs offer to attractive rewards to
the human resources. Besides this, company also requires to make promotion of the
personnel who are performing well. Through this business unit is able to encourage their
workforce more effectively and efficiently.
Recommendations for H & M
 It is recommended to H & M that it needs to make investment in other profitable projects
rather than keeping more current assets with itself. Thus, both the companies require
releasing its current assets.
 Business organization is also required to undertake promotional strategies and campaign.
It helps business unit in developing awareness among the customers about the products
which are offered by them. Through this, company is able to enhance their productivity
and profitability to the significant level. Further, H & M needs to make changes in its
existing strategies and policies. Moreover, gross and net profitability aspect of the firm in
continuously decreasing. Dividend decision of the firm is also highly dependent upon the
profit which is earned by the firm. Thus, company needs to strengthen its existing
strategic framework.
 In addition to this, H & M needs to motivate the human resources of firm in relation to
give their best efforts towards the business operations and functions. By this, company is
able to maximize the revenue and operating income of the employees.
 Along with it, H &M also needs to make balancing financial structure by keeping in mind
the ideal debt-equity ratio which is .5:1. According to this, company needs to fulfill its
monetary needs from equities rather than debt instruments (Jennifer and Krueger, 2011).
Moreover, in debt business unit is obliged to make payment of interest on amount
irrespective that they generate enough amount of profit or not. Whereas in equity,
company gives dividend to their shareholders then they generate profit. Through this,
corporation is able to reduce its financial burden.
 H & M also needs to make improvement in the cash flow of the business unit. Thus,
company requires undertaking promotional strategies and campaign to push up the sales
of firm to the large extent (Cifuentes, Ferrucci and Shin, 2005).
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4. Limitations of financial ratios
Deficiencies which are prevailed in the financial ratio analysis closely affect the
investment decisions of stakeholders are as under:
 Ratio analysis is highly based upon the accounting figures which can be manipulated by
the analyst on the basis of his own understanding. Thus, ratios offer more biased results
and thereby impacts the decision making aspect of the investors.
 Further, different type or size of firm employs different accounting methods. Due to this,
investors are unable to make comparison of the financial health and performance of
different-different organizations (Saleem and Rehman, 2011). For instance: Some
companies calculate their inventory by LIFO whereas some employs FIFO method. This
aspect creates problem in making comparison of the business performances.
 Besides this, lack of standardized accounting ratio methods also affects the result which
is derived by making financial statement analysis.
 Along with it, ratio analysis entails the relationship between the past performances. On
the contrary to this, users of financial statements or investors are highly concerned about
the current and future performance of the firm (Sherris, 2006). Moreover, investor will
enjoy high benefit only when then growth and profitability of the firm is increased to the
great extent.
 Inflation rate is also the most significant aspect which has high level of influence upon
the conclusion which is derived from ratio analysis (5 Limitations of Financial Ratios,
2015).
QUESTION 2
1. Use of investment appraisal techniques
Capital budgeting tools may be defined as the planning process which is used by the
business organization for the evaluation of long term investments. Payback period, net present
value and average rate of return are the main aspects of ‘capital budgeting’ which helps manager
in assessing the viability or profitability of project. Manager of Hilltop Company can choose
profitable project which gives higher return to them in near future.
Cash flows for both the projects
Net Profit Project A Project B
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Machine 1 Machine 2
£000’s £000,s
2016 40 10
2017 40 20
2018 40 30
2019 30 60
2020 30 70
2021 20 55
200 245
Payback period: This method of capital budgeting provides deeper insight about the time
will be taken by the firm to recover its initial investment which is £120 million (Baum and
Crosby, 2014). In this, Hilltop corporation ltd. required to select the project which have lower
pay back period.
Project A
Year
Machine 1
(net profit in
'£000)
Depreciatio
n (in £'000)
Sale of
machine
(in £'000)
Machine
purchase
(in £'000)
Cash
inflow (in
£'000)
Cumulativ
e cash
inflow
2016 40 33 73 73
2017 40 33 73 146
2018 40 33 21 -50 44 190
2019 30 10 40 230
2020 30 10 40 270
2021 20 10 30 300
Total = 200
Payback period = 1 + 47/73
= 1.64 years
Project B
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Year
Machine 2 ( net
profits £'000)
Depreciation (in
£'000)
Cash inflow (in
£'000)
Cumulative cash
inflow
2016 10 20 30 30
2017 20 20 40 70
2018 30 20 50 120
2019 60 20 80 200
2020 70 20 90 290
2021 55 20 75 365
Total 245
Payback period = 3 years
Net present value: This method of capital budgeting helps business entity in making
assessment of the profitability of project investment. Net present value method undertakes time
value of money concept. Moreover, it assumes that time has high level of impact upon the profit
which is earned by Hilltop after the predetermined time period (Haka, 2006). Under this,
company needs to select the project which has higher NPV rather than others. Moreover, when
NPV is higher than greater the probability that Hilltop Company will enjoy positive returns in
the near future.
Project A
Year Cash inflow
Discounting factor
@20% Discounted cash flow
2016 73 0.833 60.809
2017 73 0.695 50.735
2018 44 0.579 25.476
2019 40 0.482 19.28
2020 40 0.402 16.08
2021 30 0.335 10.05
19

Total discounted cash
flow 182.43
Less : Initial
investment 120
NPV 62.43
Project B
Year Cash inflow
2016 30 0.833 24.99
2017 40 0.695 27.8
2018 50 0.579 28.95
2019 80 0.482 38.56
2020 90 0.402 36.18
2021 75 0.335 25.125
Total discounted cash
flow 181.605
Less : Initial
investment 120
NPV 61.605
Average rate of return: It presents average profit which firm will attain by making
investment in the project. It provides an idea that Hilltop needs to proceed with the existing
project or not.
Project A (245000£-120000£/6)/ (120000£)*100=
17.36%
Project B (200000£ - 120000£/6)/ (120000£)*100 =
11.11%
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Recommendation: On the basis of above mentioned analysis it is recommended to Hilltop
corporation ltd. that they needs to make investment in project A rather than project B. According
to the analysis company will recover the initial investment £120 million within 1 year and 6
months if they make investment in project A rather than project B whose payback period is 3
years. In addition to this, net present value of project A is £62.43 million, whereas in project B it
is £61.60 million. Further, Hilltop ltd. will also enjoy high average benefits by investing money
on project A over the project B. Thus, it is advised to Hilltop that it needs to make investment in
project A which makes contribution in the growth and development of the business organization.
2. Limitations of capital budgeting tools
There are several deficiencies which are present in the capital budgeting tools which are
enumerated below: Payback period: One of the main limitations of payback period is that it ignores time
value of money concept which is highly important in the present business arena. Besides
this, it also prevents the cash flow which form will generate over the time period. Thus,
company is unable to make concrete decision by taking into consideration pay back
method. Net present value: In this method, analyst requires to identify the discounting factor for
making assessment of the profit aspects (Götze, Northcott and Schuster, 2008). This
method of capital budgeting offers highly realistic solution because it considers time
value of money concept. Through this, business entity can easily assess the return which
they will get after the predetermined time period. In this, company needs to select the
project which offers high and positive return to the them. Thus, if investment manager
fails to undertake appropriate discounting factor company is unable to make investment
in the right project. In addition to this, NPV method offer biased result because in this
manager undertakes discounting factor on the basis of his own understanding.
 Average rate of return method: It provides deeper insight about the average return which
organization will get after during the predetermined time period. By dividing the average
profit from the average investment business entity is able to determine the mean profit
which they will earn by investing money into the project. In this, company needs to select
the project which have high ARR. This method of investment appraisal undertakes net
21