Business Decision Making: Payback Period and Net Present Value

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.

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
Business decision is done for the short term or long term financing sources in an
organisation. The decision process is about identifying goals and gathering relevant
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:
Year Project A – Synthetic Leather Bags
Net cashflow £
Project B –Clothes Bags
Net cashflow £
1 60,000 65,000
2 68,000 69,000
3 82,000 77,000
4 109,000 105,000
5 155,000 145,000
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
YEAR Cash flow of project
A
Cumulative cash flows of
project A
Cash flow of project B Cumulative cash
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

Payback period fall between 2nd and 3rd year. An addition of 68000 of project A and 69000 of
project B and remaining of initial investment will be covered from 3rd year. 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
Years Cash flows Present value Factor
@11%
Present value of Cash
flows
1 60000 0.901 54060
2 68000 0.812 55216
3 82000 0.731 59942
4 109000 0.659 71831
5 155000 0.593 91915
Net present value = discounted cash inflows – discounted cash outflows
Net present value 147964
Net present value of Project B.
initial investment is 182000

Years Cash Flows Present value Factor
@11%
Present value of Cash
flows
1 65000 0.901 58565
2 69000 0.812 56028
3 77000 0.731 56287
4 105000 0.659 69195
5 145000 0.593 85985
Net present value = discounted cash inflows – discounted cash outflows
Net present value 144060
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's assets profile, ownership title, investor anticipations and returns, time of
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 find business 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.

REFERENCES
Books and journals
Tan, A.W.K. and Gligor, D., 2019. A decision-making framework for inventory positioning in an
omnichannel business environment. International Journal of Information Systems and
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. and Scholtz, F., 2019. Entrepreneurial decision-making: new conceptual
perspectives. Management Decision.