Advanced Management Accounting: NPV and IRR Analysis for Investment Appraisal

This report analyzes the financial viability of investing in a new machine for Alzahraa Ltd. using Net Present Value (NPV) and Internal Rate of Return (IRR) approaches. It also provides a critical analysis of sophisticated capital budgeting practices and the effect of uncertainty and irreversibility on capital budgeting decisions. The report concludes with a recommendation not to invest in the project due to negative NPV and IRR less than the cost of capital.

Advance Management
Accounting

Contents
INTRODUCTION......................................................................................................................4
MAIN BODY.............................................................................................................................4
(a) Calculate NPV and IRR and give recommendations based on the results.......................4
(b) Give a critical analysis of the applications and development of the sophisticated capital
budgeting practices.................................................................................................................5
(c) The critical analysis of the effect of uncertainty and irreversibility on capital budgeting
decisions in practice...............................................................................................................6
CONCLUSION..........................................................................................................................7
REFERENCES...........................................................................................................................8

INTRODUCTION
Management accounting can be characterized as a course of giving monetary data and
assets to the executive for decision – making. It can only be utilized by the internal sources of
the association (Gottlieb, Hansson and Johed, 2021). Alzahraa Ltd. is a new organisation
which manufactures a part of car called “Moto”. Several investment appraisal approaches are
used in this report to assess the machine's financial viability. The study gives a
recommendation for purchasing the machine by weighing the advantages, disadvantages, and
outcomes of two investment appraisal methodologies. The Net Present Value (NPV) and
Internal Rate of Return (IRR) are the approaches employed in this report (IRR). The NPV
emphasises the present value of cash flow, whereas the IRR determines the amount of interest
earned on the investment. Because of the variances in their techniques and computations, the
outcomes of these methods may not be comparable. As a result, it's a good idea to try out a
few different investment appraisal methods and grasp their merits and drawbacks before
making a final decision.
MAIN BODY
(a) Calculate NPV and IRR and give recommendations based on the results.
The NPV takes into account the time value of money and demonstrates that cash
received now is preferable than cash received later, indicating the difference between the
present value of cash inflows and outflows over time. The NPV evaluates an investment's
profitability, but the IRR approximates the return earned when the NPV of all cash flows
equals zero. Using the IRR implies that there is some risk involved in calculating the IRR
value. Due to the volatility of cash value, the discount factor (DF) is liable to vary, posing a
risk and uncertainty to the investment's future (Amoako and et. al., 2021). Furthermore, when
making investment selections, both investment assessment approaches have their own set of
advantages and disadvantages.

Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Selling Units 4000 4800 5760 6912 8294.4
Selling Price per unit 240 252 264.6 277.83 291.7215
Variable Cost 160 176 193.6 212.96 234.256
Fixed Cost 52 57.2 62.92 69.212 76.1332
Revenue 960000 1209600 1524096 1920361 2419655
Cost of Goods Sold (Variable Cost) 640000 844800 1115136 1471980 1943013
Cost of Goods Sold (Fixed Cost) 208000 274560 362419.2 478393.3 631479.2
Profit before Tax 112000 90240 46540.8 -30011.9 -154837
Tax (@15%) 0 16800 13536 6981.12 -4501.79 -23225.6
Profit after Tax 0 112000 73440 33004.8 -36993 -150336 -23225.6
Capital
Machinery Cost 50000
Training Costs 10000
Tax saving 2250 2148.75 2052.056 1959.714 1871.527
Working Capital cash flow -288000 -74880 -94348.8 -118879 -149788 725896.4
Residual Value 6000
Cash flow After Tax -348000 37120 -18658.8 -83725.9 -184729 583520.6 -21354.1
Present value @ 8% 1 0.926 0.857 0.799 0.735 0.681 0.63
Present value of Cash Flow -348000 34373.12 -15990.6 -66897 -135776 397377.5 -13453.1
NPV -148366
IRR can be calculated by taking the trial and error method for analysing the lower discount
rate, as the NPV calculated is negative. So, now the other present value taken is 1%, by
which the NPV calculated is -53546.8.
IRR = LDR + (NPV1 / NPV2 - NPV1) * (HDR – LDR)
= 1 + ( -53546.8 / -148336 - -53546.8) * (8 – 1)
= 1 + (-53546.8 / -94789.2) * 7 = 1 + 3.95 = 4.95%
Recommendation: It is recommended not to invest in this project as it gives a negative net
present value. It is not good for the business purposes; it will tend to decrease the net profits
as well of the organisation. In addition to this, the IRR is 4.95 % which is less than the cost of
capital, i.e., 8 %. It both the cases the project is not giving returns; in fact, it is giving a loss
for the organisation. So, it will be suggested to drop this project plan.
(b) Give a critical analysis of the applications and development of the sophisticated capital
budgeting practices.
The allocation of resources for making a decision which is important for the organisation in
terms of the proposed investment projects by the top management is known as the
implementation of future strategies of a firm (de Lautour, 2019). This can be sorted through
the techniques of sophisticated capital budgeting practices (SCBP). Game Theory and Real

Option Reasoning are examples of SCBP. The one focuses on strategizing a company's 'game
plan,' while the other bases its practise on real-life logic. GT is based on the idea of tailoring
a company's business plan to rational players called strategic decision-makers and then
assessing their results. Specific uncertainties, according to GT, can affect the best investment
criterion. ROR, on the other hand, is based on the idea of providing managers with rational
financial options when an investment presents a chance. Expansion, delay, postponements,
and mothballing are some of these alternatives (Nsor-Ambala, 2020).
Traditional approaches such as NPV and IRR are supplemented rather than replaced
by SCBP. These alternatives provide organisational flexibility because future decisions may
result in potential rewards. The readiness to invest is a significant difference between ROR
and GT, since ROR prefers to wait investment in order to acquire more data, but GT
investigates the concept of 'losing out' the investment to another company interested in
investing in advance. Advanced capital budgeting techniques such as NPV and IRR, on the
other hand, consider the time value of money, cash flows, and risk.
In the Alzahraa, the value of money of time is considered to be an important factor, as
it is the new organisations in the market and keeping the business solvent is very crucial and
essential. Although, due to lack of concern in the future investment and cost, it has to
eliminate the project because it will incur the losses to the firm.
When using SCBP, organizations are expected to spend more time, resources, and
money implementing it efficiently. The larger companies are more likely to adopt different
decision-making practices than smaller companies because of the level of facilities,
resources, and assets that need to implement these ideas. They are exposed to greater
expertise in this area, which results in them having greater capacity and willingness to adapt
to different household practices. Companies are more likely to adopt SCBP when there is
financial uncertainty rather than social market and input uncertainty. Consequently, capital
planning helps managers select investments with high returns and an acceptable risk of
return.
(c) The critical analysis of the effect of uncertainty and irreversibility on capital budgeting
decisions in practice.
Companies use SCBP when there is a certain risk and uncertainty associated with it. In
general, the higher the risk, the more valuable is an investment. It shows that uncertainty is
the main difference between existing information and unknown and unavailable information.
Additionally, companies adjust their payback period and discount factor to handle this, which

inevitably delays investment decisions in the long run. Small firms are more inclined to
irreversibility and uncertainty, so their decision to refrain from investing is usually based on a
lack of funds. In the case of Alzahraa, a company that has been new in the market and has
started its operation for approximately two years, investing in machines required several
investment appraisal methods to be used to make it a viable option for the company.
However, larger companies often have separate owner and control teams, which can reduce
the uncertainty in investment valuation. Managers have greater control over resources and
assets without suffering the consequences of bad decisions. This effect should be offset if
there is a viable option to await an investment decision (Cowton, 2018).
In relation to this, a SCBP, for example, ROR uses non- systematic and systematic
risk, handling the level of irreversibility. When a real option offers more flexibility, most
corporations employ payback approaches such as the Capital Asset Pricing Model (CAPM),
which solely deals with non-systematic risks via portfolio theory and diversification and does
not provide a procedure for analysing systematic risk. ROR does not challenge the dominance
of NPV, IRR, or PB, but it does provide a better understanding of irreversibility and
uncertainty. Using standard capital budgeting approaches like NPV or IRR has become a
bookmark, leading in the certainty of these on the capital budgeting decisions. Demand
uncertainty, a lack of internal capital, high interest rates, and uncertain interest rates are all
factors that contribute to investment delays. This is because to the fact that smaller businesses
choose high interest rates and UC above uncertainty and finance.
CONCLUSION
For the foreseeable future, capital budgeting approaches will be adopted to varying degrees,
and corporations will choose their favourite way. Most businesses bend the rules to achieve
their own goals; it's a complex topic that's tough to summarise. In the case of Baby Boss Ltd,
using both NPV and IRR to determine whether it was a good investment was ideal. Further
analysis, is done to analyse the finer aspects of the investment using sophisticated capital
budgeting methods. Capital budgeting is a term that encompasses two important decisions: an
investment decision and the financial decision that goes along with it. Acceptance of the
investment means that the company will commit itself financially to the initiative on an
arbitrary basis, including risk and uncertainty. Project delays, cost overruns, and legal
restrictions can result in total costs being suspended or increased. In addition, companies

choose to invest in their future (in terms of direction, growth and expansion). This can have
an impact on future projects that companies are investigating and evaluating.
REFERENCES
Books and Journals
Gottlieb, U., Hansson, H. and Johed, G., 2021. Institutionalised management accounting and
control in farm businesses. Scandinavian Journal of Management. 37(2). p.101153.
Amoako, G.K. and et. al., 2021. Institutional isomorphism, environmental management
accounting and environmental accountability: a review. Environment, Development
and Sustainability. pp.1-16.
de Lautour, V.J., 2019. Historical Perspectives on Strategy, Ethics and Management
Accounting. In Strategic Management Accounting, Volume III. (pp. 1-50). Palgrave
Macmillan, Cham.
Nsor-Ambala, R., 2020. Impact of exam type on exam scores, anxiety, and knowledge
retention in a cost and management accounting course. Accounting Education. 29(1).
pp.32-56.
Cowton, C.J., 2018. Management Accounting and New Information Technology.
In Management Information Systems. (pp. 115-126). Routledge.