Business Finance - Assignment

RUNNING HEAD: BUSINESS FINANCE
Finance

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Contents
Introduction...........................................................................................................................................2
Question 1.............................................................................................................................................2
Question 2.............................................................................................................................................3
Question 3.............................................................................................................................................3
Question 4.............................................................................................................................................4
Question 5.............................................................................................................................................5
Question 6.............................................................................................................................................7
Question 7.............................................................................................................................................7
Question 8.............................................................................................................................................8
Conclusion.............................................................................................................................................8
References...........................................................................................................................................10
Appendix.............................................................................................................................................12

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Introduction
Capital budgeting techniques are basically different methods used for evaluating a project.
These techniques helps in knowing the viability and feasibility of an investment project and
assist in taking decisions related to them (Baker, Jabbouri & Dyaz, 2017). The report contains
an analysis of the project undertaken by Booli Electronics. Booli is planning to expand its
operations and for this it wanted to know about the profitability and sustainability of the
project. In order to carry out the analysis, capital budgeting techniques such as Net present
value, pay-back period, profitability index and internal rate of return are been used in the
report. On the basis of this the decisions and recommendations are provided in the later part.
The report also include a sensitivity analysis of NPV with a change in the price and quantity.
Impact of the same is been discussed in the further part of the report. In the last, a conclusion
is been given covering the findings of the analysis.
Question 1
Payback period is describes as amount of time required by a project to recoup the initial
investment.in other words, it is simply the break-even point of a series of cash flows. A non-
discounted payback period is the one which does not takes into account the time value of
money. This is the only drawback of the method. However, it is the simplest technique used
for evaluation and is very important for the investors or the organizations to determine the
payback period for taking related decisions (Chaysin, Daengdej & Tangjitprom, 2016).
In case of Booli Electronics, the PBP of their project is 2.20 years which means that the
project will cover the initial outlay in less than three years of its life. After that the cash flow
generated will be the profits for the company (Refer Appendix 1).

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Question 2
The profitability index is that capital budgeting tool which reflects profitability of the project.
The fundamental rule of PI is that the project is accepted when PI is greater than one and is
rejected when it is less than one. It can be calculate by adding NPV to the initial investment
and dividing their sum with initial outlay or investment. Generally, proposals having high PI
are more desirable (Moyer, McGuigan, Rao & Kretlow, 2011).
PI = (NPV+ initial investment)/Initial investment
Primary advantage of this method is that it allows quantifying the amount of value created at
per unit of investment. It gives the values in absolute measure. The drawback of this method
is that it may not be suitable for deciding about the mutually exclusive projects (Shapiro,
2008).
Booli electronics has a PI of $1.68, which is greater than 1 and implies that company will
earn profits in its manufacturing business of new SSHA. Project’s PI also satisfies the rule of
profitability index and hence is regarded as profitable. Looking at the PI and PBP, company
should go for investing in this project. However, the PI ranking can be conflicting in case of
mutually exclusive projects as the size of the investment differs (Refer Appendix 1).
Question 3
Internal rate of return is that when the present value of cash outflow is equal to the present
value of cash inflow. In other words, the point where NPV of a project is zero. The decision
rule for IRR is that accept those projects which have IRR more than the discounting rate and
reject the one having IRR less than the discounting rate (Venkatesh & Gugloth, 2017). When
the internal rate of return is more than the cost of capital, it means the project is profitable
and the company can pursue it. One benefit of using IRR is that it does not require calculation

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of hurdle rate or required rate of return. One pitfall is that it ignores the economies of scale
(Gotze, Northcott & Schuster, 2016).
The discounting rate decided by Booli Electronics is 11% and the project has an IRR of 34%.
This means that manufacturing a new SSHA will give more profits to the company, as it has
high IRR and is desirable to go with according to the decision rule of the method (Refer
Appendix 1).
Question 4
Net Present Value is also one of the capital budgeting technique used for evaluating a project
in which investment is required to be made. This method is considered to the most popular
and accurate for making decisions regarding the investments. It measures the profitability of a
project and rank them according to their viability (Bierman & Smidt, 2014). NPV method is
superior to all the other techniques because it has no serious flaws. The primary advantage of
this technique is that it considers the time value of money and can rank the mutually
exclusive projects of different sizes and horizon. The only limitation to this concept is that it
uses discounting rate and relies on future cash flows which are estimated and are uncertain
but the same issue is with other methods also (Daunfeldt & Hartwig, 2014).
Net present value is calculated as follows:
NPV = PV of cash inflow – PV of cash outflow
A project having high and positive NPV is considered to more suitable and acceptable than
the one which has a negative NPV. The decision taken on the basis of this method follow
some criteria, which is as follows:
 NPV > 0 = Accept
 NPV < 0 = Reject

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 NPV = 0 = Accept or reject
The above criteria helps the investors to decide and evaluate the feasibility of a proposal
(Leung, Springborn, Turner & Brockerhoff, 2014).
Looking at the case of Booli Electronics, the NPV of the project is $38,728,290.58 which is
positive and reasonably higher. According to the above criteria, the company must accept the
project as it will generate positive cash flows in future and will be profitable for the
organization. It also implies that the total shareholder wealth of the firm will increased by that
amount (Refer Appendix 1).
Question 5
Sensitivity analysis is the technique used to measure the changes in the dependent variable
when the values of an independent variable is changes under some set of assumptions. In
other words, it is also known as What-if analysis that it is a way to predict the outcome of the
changes made (Borgonovo, 2017).
As per the calculations done it can be said that NPV is highly sensitive to the changes in the
price of new SSHA. The below table shows the variations in NPV of the project as and when
the prices are increased or decreased.
Base case (prices) Best case (prices) Worst case (prices)
$ 685.00 $ 700.00 $ 570.00
$ 702.13 $ 720.00 $ 585.00
$ 719.68 $ 740.00 $ 595.00
$ 737.67 $ 780.00 $ 610.00
$ 756.11 $ 800.00 $ 625.00
NPV $ 38,728,290.58 $ 44,463,757.08 $ 10,012,019.71

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The above table shows three scenarios that are normal case, best case and worst case
scenarios. All the cases are properly analysed and then the decision is been take.
 Normal case: Under this scenario, the selling price of new SSHA are taken as it was
decided by the company. No changes are been made and the NPV is calculated as per
them. The NPV under this situation is $38,728,290 which shows that the project is
profitable and can be accepted.
 Best case: This is that case where the amount of NPV is highest with less variations
in the selling price of SSHA. Under this situation, the sale price of the project has
been increased through some extent because of some market factors that influence
prices to a great extent. Due to such upsurge the value of NPV also rises to
$44,463,757.08, making the project more profitable than earlier. This is called best
case scenario because here the NPV is highest which implies that the manufacturing
of new SSHA will generate more profits if sold at increased prices.
 Worst case: The circumstances where the net present value of a project is low or
negative and the selling price is also reduced is known as worst case scenario. From
the table it can be said that, in this case the price are been reduced to some extent as
compare to the base case prices and as a result of which, the NPV of the project also
falls to $10,012,019.71 making it less profitable.
So as per the sensitivity analysis, it can be said that the change in the price do have a
significant effect on NPV. From the above three scenarios, the best one is that where the
prices are increased and highest NPV is recorded.

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Question 6
Fluctuations in selling price affected the NPV to a great extent and so does the changes in
quantity sold. The modification in number of quantity sold of SSHA also impacted its NPV.
The below table show the clear impact of quantity variations.
Base case (Quantity) Changes in quantity
85000 85000
136000 87125
102000 89303
74000 91536
63000 93824
NPV $ 38,728,290.58 $ 34,122,641.37
It can be observed from the table that at the decided quantity of SSHA, the NPV is
$38,728,290.58 keeping the project profitable. However, as and when the quantity sold
changes the NPV also changes. A constant increase can be observed in the changed quantity.
As a result of which, the NPV falls to $34,122,641.37 a compare to the earlier one. Hence, it
can be interpreted that with an increase in the quantity the NPV reduces showing an inverse
effect. While the same in not with the prices. When the prices increase, NPV also rises and
vice versa. Overall, it can be said that changes in both the prices and quantity affect the NPV
negatively and positively.
Question 7
From the capital budgeting analysis following factors are been identified:
 Pay-back period is shorter with 2.2 years.
 Profitability index is 1.68 which is greater than 1.

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 Internal rate of return is 34% which is more than the required rate of return of 11%/
 Net present value is positive and high at $38,728,290.58 (Refer Appendix 1).
By considering the above points, Booli Electronics must manufacture the new SSHA as it
will be the most profitable project of the company. It will generate high cash flows as high
IRR, NPV, PI and shorter payback period. Apart from this, the product will made increased
sales during its life (Nichol & Dowling, 2014).
After taking into account the financial factors company also look as the non-financial aspects
of the project. Such as the new SSHA will have several new and unique features like Wi-Fi
tethering and access to a large number of music streaming services including Amazon,
Spotify etc. on the basis of this, Booli should accept this project.
Question 8
The overall sales of Booli can be reduced if the company only focus on the production of new
SSHA. Trying of another model can impact the sales of others. However, as SSHA being the
unique in nature and its production offering more profits to the company, then Booli should
produce this new product. As the introduction of SSHA shows the increasing trend in the
sales of Booli Electronics, the same is reduced later on due to the reduction in quantity. The
way reduction in sales impact the analysis is that it can reduce the profitability of the project
by reducing the value of cash inflows. Then the project will be no longer profitable and may
have low NPV and IRR. So, it can be said that the reduction is sale of other models will leave
a significant impact on the overall analysis for the company (McCombie & Thirlwall, 2016).
Conclusion
From the above report, it can be concluded that capital budgeting techniques are very
important while analysing a particular investment project. The first part of the report
concludes that various methods of investment appraisal are used to evaluate the usefulness of

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manufacturing new SSHA. It is recommend that the company must go for the production of
the new SSHA as it is economically and financially feasible and also has some unique
features.
The second part of the report deals with the sensitivity analysis of NPV. The outcome of the
analysis is that when the prices rises, the NPV also increases and vice versa. While in case of
quantity change, an inverse effect is there. Increase in quantity reduces the NPV of the
project. Overall, it can be concluded that Booli Electronics Limited must accept this new
production of SSHA.

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References
Baker, H.K., Jabbouri, I. & Dyaz, C. (2017). Corporate finance practices in
Morocco. Managerial Finance, 43(8), 865-880.
Bierman Jr, H. & Smidt, S. (2014). Advanced capital budgeting: Refinements in the
economic analysis of investment projects. Oxon: Routledge.
Borgonovo, E. (2017). Sensitivity Analysis: An Introduction for the Management
Scientist (Vol. 251). Switzerland: Springer.
Chaysin, P., Daengdej, J. & Tangjitprom, N., (2016). Survey on Available Methods to
Evaluate IT Investment. Electronic Journal Information Systems Evaluation
Volume, 19(1).
Daunfeldt, S.O. & Hartwig, F. (2014). What determines the use of capital budgeting
methods?: Evidence from Swedish listed companies. Journal of Finance and
Economics, 2(4),101-112.
Gotze, U., Northcott, D., & Schuster, P. (2016). INVESTMENT APPRAISAL. (2nd ed.). New
York: Springer.
Leung, B., Springborn, M.R., Turner, J.A. & Brockerhoff, E.G. (2014). Pathway‐level risk
analysis: the net present value of an invasive species policy in the US. Frontiers in
Ecology and the Environment, 12(5), 273-279.
McCombie, J. & Thirlwall, A.P (2016). Economic growth and the balance-of-payments
constraint. New York: Springer.

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Moyer, R. C., McGuigan, J., Rao, R., & Kretlow, W. (2011). Contemporary financial
management. (13th ed.). USA: Cengage Learning.
Nichol, E. & Dowling, M. (2014). Profitability and investment factors for UK asset pricing
models. Economics Letters, 125(3), 364-366.
Shapiro, A. C. (2008). Capital budgeting and investment analysis. India: Pearson Education.
Venkatesh, M., & Gugloth, D. (2017). A Review of Capital Budgeting Techniques.
International Journal of Economics and Management Studies (Retrieved from
http://www.internationaljournalssrg.org/IJEMS/2017/Special-Issues/ICEEMST/
IJEMS-ICEEMST-P102.pdf

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Appendix
NPV
Years 0 1 2 3 4 5
Cash
outflow
$ -
56,820,000.0
0
Cash
inflow
$
18,955,000
.00
$
33,044,600.0
0
$
24,695,41
1.25
$
17,579,68
5.72
$
37,095,91
4.94
NPV
$
38,728,290.5
8
Payback period
Years Cash flows cumulative
0 $ -56,820,000.00
1 $ 18,955,000.00 $ -37,865,000.00
2 $ 33,044,600.00 $ -4,820,400.00
3 $ 24,695,411.25 $ 19,875,011.25
4 $ 17,579,685.72 $ 37,454,696.97
5 $ 37,095,914.94 $ 74,550,611.91
PBP 2.20

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Profitability Index
NPV $ 38,728,290.58
Initial Investment $ -56,820,000.00
PI $ 1.68
IRR
Years Cash flows
0 -56820000
1 $ 18,955,000.00
2 $ 33,044,600.00
3 $ 24,695,411.25
4 $ 17,579,685.72
5 $ 37,095,914.94
IRR 34%