Business Decision Making: Payback Period and Net Present Value
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This report compares two capital investment techniques, Payback Period and Net Present Value, to evaluate two projects suggested by the strategic manager of S&P plc. The report also discusses the importance of financial and non-financial factors in investment decision making.
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Contents INTRODUCTION...........................................................................................................................3 Business Decision Making..........................................................................................................3 MAIN BODY..................................................................................................................................3 Payback period.............................................................................................................................3 Net Present value.........................................................................................................................5 Financial factors...........................................................................................................................7 Non-financial factors...................................................................................................................7 CONCLUSION................................................................................................................................7 REFERENCES................................................................................................................................8 Books and journals......................................................................................................................8
INTRODUCTION Business Decision Making Businessdecisionisdonefortheshorttermorlongtermfinancingsourcesinan organisation.Thedecisionprocessisaboutidentifyinggoalsandgatheringrelevant information in order to take necessary decision. The simple words, it refers as an operational decision. Decision maker need various techniques or method for decision making model and understand, overcome the challenges. This report contains the comparison between two capital techniques to select one project either A or B suggest by strategic manager. In the end, report consider financial or non-financial factors and their implication on investment decision(Tan and Gligor, 2019). MAIN BODY Initial investment required for project A (synthetic leather bags) is £185,000 and for project B (clothes bags) is £182,000. The discount rate required is at 11%. The net cash flows for two projects can be summarized as below: YearProject A – Synthetic Leather Bags Net cashflow £ Project B –Clothes Bags Net cashflow £ 160,00065,000 268,00069,000 382,00077,000 4109,000105,000 5155,000145,000 An organisation uses one or more than one techniques for capital investment evaluation. Some most used techniques are payback period, Net present value, internal rate of return and many more. Payback period Payback period about how much time it takes to covers the initial investment cost. In accounting terms, the time taken to reach its investment and to reaches a breakeven point. It
is interpreted by dividing the amount invested in company with the annual cash flow. The time needed to recover initial cash investment(Taufik, 2018) . Payback period = Initial investment / yearly cash flows Payback period = last year cash flow + (cash flows at the end of that year / cash flow after that year) calculating the annual expected net flow after tax over project life. The cash flow can be in uniform manner over life of project, the calculation is done as: Payback period for project A and project B YEARCash flow of project A Cumulative cash flows of project A Cash flow of project BCumulativecash flows of project A 1£60,000.00£60,000.00£65,000.00£65,000.00 2£68,000.00£128,000.00£69,000.00£134,000.00 3£82,000.00£210,000.00£77,000.00£211,000.00 4£109,000.00£319,000.00£105,000.00£316,000.00 5£155,000.00£474,000.00£145,000.00£461,000.00 185,000 – 128,000 Payback period for project A = 2 += 2 years 8 months 82,000 182,000 -134,000 Payback period for project B = 2 += 2 years 8 months 77,000
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Payback period fall between 2ndand 3rdyear. An addition of 68000 of project A and 69000 of project B and remaining of initial investment will be covered from 3rdyear. So payback period of project A is 2 years 8 month project B is 2 years 7 months. Net Present value Net present value is the financial method which is done find out the feasibility of project investment(Oliveira and et.al, 2021).It’s the difference of present value of cash inflow and its outflow over a period of time. It shows the present value of cash flow which is generate in future and then compared with initial investment. Cash flows Net present value(NPV) =------------- - initial investment (1 + i) t net present value of project A. initial investment is 185000 YearsCash flowsPresent value Factor @11% PresentvalueofCash flows 1600000.90154060 2680000.81255216 3820000.73159942 41090000.65971831 51550000.59391915 Net present value = discounted cash inflows – discounted cash outflows Net present value147964 Net present value of Project B. initial investment is 182000
YearsCash FlowsPresent value Factor @11% PresentvalueofCash flows 1650000.90158565 2690000.81256028 3770000.73156287 41050000.65969195 51450000.59385985 Net present value = discounted cash inflows – discounted cash outflows Net present value144060 In both project NPV is affirmative, the project should be considerably, Project A is better than project B. S&P plc is bag manufacturing company who are considering two project which are produce leather bags or cloth bags. For this judgment their strategic manager considering to evaluate by using Net present value (NPV) and Payback period (PBP) for both the projects.The payback period is based on risk perceptive, since it’s about the risk of initial investment for how long time. If results are analysed of project which are done payback period, then result is better if payback is less and the drop longer time ones. In this Project A and Project B have a payback period of 2.695 means 2 years and 8 mouth and 2.623 is 2 years and 7 months. The difference is minor but the investment in project B is less than A hence less risk. The asset life span is over after its initial investment is generated. The net present value is most famous tools to evaluating capital project.NPV technique eliminates the time period element in weighing choice of projects if compared to payback method concentrates on time needed for return on investment(Paik, Lee and Pak, 2019).It finds out the total expected value of the project. On comparing the project, A and project B. It’s easier to find which is more favourable and better choice to invest in. Net present value of Project A equal to £147964 and net present value of Project B equal to £144060. Both the figures are affirmative. NPV of project A is more which means its more profitable than the other one. The
difference between both projects is in minute. To have an advance understanding profitability index will be used here, dividing each project's NPV to its upfront costs. The profit index if project A is higher means more profit made at each 1 pound invested. Financial factors Financial factors show the outcome of investment in cash flow of business. Internal factors that impact financial decisions comprises of the nature of business, the size of the organisation, the anticipated rate of return, the cost and threats or uncertainty involved, the company'sassetsprofile,ownershiptitle,investoranticipationsandreturns,timeof establishment and liquidity. The effect of financial factors on the business compare the ROI with the cost of capital and the cost of financing(De Winnaar and Scholtz, 2019). Financial element increases the production flexibility and quality control. It shows the growth of the market and of market share. It also improves the goodwill, boast morale and job satisfaction and revenue. Non-financial factors Non-financial factors for investment are the following- meeting the obligations for current and future legislature computing with good industry standards and practice increasing staff motivation, recruit and hold employees improving relationships customers and stakeholders increasing business status and CSR emerging the capabilities of business, such as increasing revenue and training new areas or improving management systems forecasting and allocating with future threats, like protecting intellectual assets against likely competition. CONCLUSION To conclude, the manager of S&P plc has introduced two project A and Project B. This report analysis two techniques of capital investment which is Net present value and payback period. To findbusiness proposals which is better and which final decision.The manger should select the project A because it better than project B. The importance of financial and non- financial factors on investment decision making is also discussed.
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REFERENCES Books and journals Tan, A.W.K. and Gligor, D., 2019. A decision-making framework for inventory positioning in an omnichannelbusinessenvironment.InternationalJournalofInformationSystemsand Supply Chain Management (IJISSCM).12(1). pp.81-94. Taufik, C., 2018. Go/No-Go Decision-Making Method on Business Development of Software Development in Indonesia.Journal of Entrepreneurship, Business and Economics.6(2). pp.71-90. Oliveira, A.S. and et.al, 2021. Multiple criteria decision making and prospective scenarios model for selection of companies to be incubated.Algorithms.14(4). p.111. Paik, Y., Lee, J. M. and Pak, Y. S., 2019. Convergence in international business ethics? A comparative study of ethical philosophies, thinking style, and ethical decision-making between US and Korean managers.Journal of Business Ethics.156(3). pp.839-855. De Winnaar,K. andScholtz,F., 2019. Entrepreneurialdecision-making:newconceptual perspectives.Management Decision.
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