Analysis of Payback Period, Net Present Value, and Financial and Non-Financial Factors in Decision Making

This essay analyzes the payback period, net present value, and financial and non-financial factors in decision making for X Plc. It compares two projects and provides recommendations based on the analysis.

Business decision making

Contents
ESSAY TOPIC................................................................................................................................1
ESSAY BODY................................................................................................................................1
Introduction..................................................................................................................................1
Main body....................................................................................................................................1
Conclusion...................................................................................................................................5
REFERENCES................................................................................................................................6

ESSAY TOPIC
“An analysis on payback period, net present value, and financial and non financial factors
and how they aid in decision making”
ESSAY BODY
Introduction
X Plc is a vehicle parts manufacturing company which operates in the region of United
Kingdom and few parts of Europe. This organisation is planning to invest in a new business, for
which they have finalised two distinctive projects. These projects are analysed in order to aid X
Plc in decision making by the help of NPV, Payback period and other financial and non financial
factors (Fry, 2019).
Main body
Net present value is the time value of money which a project can facilitate with to an
organisation (Chen, Treviño and Humphrey, 2019). This the difference between the predicted
cash inflows and outflows which assists in computing the future profitability and viability of a
project (Hopkinson, 2017). For the case of X plc, two projects which are Project A
“Technological project” and Project B “Mechanical project” are compared by determining NPV
of both the projects.
Formula of NPV:
Calculation of NPV:
PROJECT A: TECHNOLOGICAL PROJECT
Formula Calculation Result
Net cash flow for year 1 (Cash flows) / ( 1 + r)t (8000) / (1+10%)1 7272.727273
Net cash flow for year 2 (Cash flows) / ( 1 + r)t (10000) / (1+10%)2 8264.46281
Net cash flow for year 3 (Cash flows) / ( 1 + r)t (12000) / (1+10%)3 9015.777611
Net cash flow for year 4 (Cash flows) / ( 1 + r)t (15000) / (1+10%)4 10245.20183
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Net cash flow for year 5 (Cash flows) / ( 1 + r)t (19000) / (1+10%)5 11797.50514
Sum of net cash flows 46595.67466
Less: initial investment 20000
NPV 26595.67466
PROJECT B: MECHANICAL PROJECT
Formula Calculation Result
Net cash flow for year 1 (Cash flows) / ( 1 + r)t (10000) / (1+10%)1 9090.909091
Net cash flow for year 2 (Cash flows) / ( 1 + r)t (15000) / (1+10%)2 12396.69421
Net cash flow for year 3 (Cash flows) / ( 1 + r)t (17000) / (1+10%)3 12772.35162
Net cash flow for year 4 (Cash flows) / ( 1 + r)t (19000) / (1+10%)4 12977.25565
Net cash flow for year 5 (Cash flows) / ( 1 + r)t (20000) / (1+10%)5 12418.42646
Sum of net cash flows 59655.63703
Less: initial investment 30000
NPV 29655.63703
By computing NPV of both the projects, it has been seen that present value of project B is
higher than the project A that is £29655.63 and £26595.67 respectively. Higher NPV of project B
implies that the if X plc selects this project then they will be able to earn high profits against
their initial investment. From the NPV determination point of view, this company is advised to
make a decision in favour of mechanical project.
Payback period is a financial measure which helps to ascertain the time period in which
initial cost of a project can be recovered by the organisation (Si and et.al., 2016). This measure is
a length of time period which a project takes to reach at the situation of break even; i.e., no profit
and no loss. For the case of X plc, payback period is calculated so that viability and efficiency of
both the projects can be determined.
Formula of PBP
PROJECT A: TECHNOLOGICAL PROJECT
Year Net cash flow Cumulative Cash
Flow
1 8000 8000
2

2 10000 18000
3 12000 30000
4 15000 45000
5 19000 64000
The initial investment for this project is £20000. Now, £18000 is recovered in Year 2 and
£2000 remains unrecovered.
So, Payback period = 2 + (2000/12000*12)
= 2 + 2
= 2 years 2 months
PROJECT B: MECHANICAL PROJECT
Year Net cash flow Cash Flow
1 10000 10000
2 15000 25000
3 17000 42000
4 19000 61000
5 20000 81000
The initial investment for this project is £30000. Now, £25000 is recovered in Year 2 and
£5000 remains unrecovered.
So, Payback period = 2 + (5000/17000*12)
= 2 + 3.52
= 2 years 3.52 months
From the above numerical analysis, it is evident that payback period of project A is 2
years and 2 months which is slightly less than payback period of project B that is 2 years and
3.52 months this implies that both the project will take approximately similar time to recover
their initial investments. The only difference which can be seen is that project A is slightly
efficient than project B as this project will recover initial cost faster with the matter of few days.
Apart from NPV and PBP, there are few other financial and non financial factors as well
which can aid X plc to take reliable decision for their growth and development. Some of these
financial factors are Interest rates and economic growth. And some of the non financial factors
include Industry stability and future legislations (Esch, Schulze and Wald, 2019).
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SWOT is the tool that help to determine associated strengths, weaknesses, opportunities
and threats with project (Black, 2019). The importance of same in decision making is significant
as strength help to ascertain the viability of project to grab the opportunities along with power in
reduction of threats. This aid in selection of best project which is most compatible in nature at
internal and external environment.
PESTLE is the framework that includes determination of the impact of external factors
over project (Baker, 2018). This aid in ascertainment of viability of project in future on the basis
of associated opportunities and power of an organization to overcome threats. This help in
selection of project which ascertain all positive impact from the external factors in future as they
linked with amount of profitability.
Interest rates are the costs which an organisation has to pay for the purpose of
borrowing (Burgas, Arlidge and Addison, 2018). X plc is planning to invest in a new project for
which they have to borrow funds from banks. In current UK economy, new businesses are
favoured and provided by loans with low interest rates. As project B has higher profitability
margin, this will help them to procure loans at effective rates with the guarantee of their prospect
future profit margins. Economic growth is also a financial factor which influences the decision
of selecting a specific project. Due to high economy growth patterns in United Kingdom, X plc
can select any project but it will be more viable to select a project by which they can earn more
profit and that is Project B.
Non financial factor such as Industry stability is an important factor which can assist in
process of decision making. The manufacturing industry of UK is stable in which a trend of
investing in mechanical industry is observed. This implies that if X plc invests in project B that is
a mechanical project then it has higher chances of growth as mechanical industry is currently
growing at rapid speed in the region of United Kingdom (Mechanical and technological industry
of United Kingdom, 2019). Future legislations are also a non financial factor which is related
with the future governmental laws which can affect the project and its investments. UK is
currently facing the issue of BREXIT due to which there are high chances of experiencing new
laws regarding trade and business. In such situation, it is advised to X plc to consider project B
as with this project they can at least earn high profit and will be able to cover all their
investments in just the period of 2 years and 3 months.
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Conclusion
From the above computations of net present value and payback period along with few
financial and non financial factors, a conclusion is evidently developed that project B is much
more effective and efficient than project A as it is able to generate more profit, is able to cover
the initial cost in approximately same time as project A and other factors are in favour of
mechanical project rather than a technological project. So, with this conclusion, X plc is advised
to take a reliable decision in the favour of project B so that they can get higher chances of growth
and development in a dynamic environment.
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REFERENCES
Books and Journals
Esch, M., Schulze, M. and Wald, A., 2019. The dynamics of financial information and non-
financial environmental, social and governance information in the strategic decision-
making process. Journal of Strategy and Management.
Fry, G. S., 2019. Business statistics a decision-making approach. Pearson Education Limited.
Hopkinson, M., 2017. Net Present value and risk modelling for projects. Routledge.
Si, J. and et.al., 2016. Assessment of building-integrated green technologies: A review and case
study on applications of Multi-Criteria Decision Making (MCDM) method. Sustainable
Cities and Society. 27. pp.106-115.
Black, K. U., 2019. Business statistics: for contemporary decision making. Wiley.
Baker, A. J., 2018. Business decision making. Routledge.
Burgass, M. J., Arlidge, W. N. and Addison, P. F., 2018. Overstating the value of the IUCN Red
List for business decision‐making. Conservation Letters. 11(3). p.e12456.
Chen, A., Treviño, L. K. and Humphrey, S. E., 2019. Ethical champions, emotions, framing, and
team ethical decision making. Journal of Applied Psychology.
Online
Mechanical and technological industry of United Kingdom. 2019. [Online]. Available through:
<https://www.prospects.ac.uk/jobs-and-work-experience/job-sectors/engineering-and-
manufacturing/overview-of-the-engineering-and-manufacturing-sector-in-the-uk>
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