Comparison of Payback Period and Net Present Value for Business Finance Projects

This report discusses the importance of business finance and how to compare different projects based on their payback period and net present value. It includes a detailed analysis of seven different projects and their rankings based on these two factors. The report also highlights the concept of mutually exclusive projects and how to choose between them.

Business Finance
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Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
TASK A:.................................................................................................................................3
TASK B................................................................................................................................12
TASK C................................................................................................................................13
TASK 4
Comparison between centralised and decentralised procurement and their benefits. 15
CONCLUSION..............................................................................................................................17
REFERENCES..............................................................................................................................18
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INTRODUCTION
Finance is important for ever business. Like for human without heart they can’t survive in the
same way finance is the heart of the organisation without which they cannot live. They plays a
vital role for the day the entrepreneur think of establishing the venture till the day they didn’t
stop working. So business finance means the capital that is available to the organisation so that
they can meet their requirement and work on daily basis. With the adequate fund company can
effectively handle their unforeseen event without distracting the operations. With the help of the
business finance they can diversify their activity in different ways (DISEMBER, 2021).
MAIN BODY
TASK A:
a) Pack back period for all projects are as follow:
Discounted payback period=
Year of negative cumulative flow + (negative cumulative cash flow / total discounted flow
Project A:
year Cash flow Present value
PV$1=1/(1+i)n
Discounted
cash flow
Cumulative
discounted
flow
0 -
1,00,00,000
1.000 -1000000 -1000000
1 3,00,000 0.9091 272730 -727270
2 3,00,000 0.8264 247920 -479350
3 3,00,000 0.7513 225390 -253960
4 3,00,000 0.683 204900 -49060
5 3,00,000 0.6209 186270 137210
6 3,00,000 0.5645 169350 306560
The payback period for the project A will lies between 4 to 5 year
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Project A = 4 + (-49060 / 169350)
= 4.24 years.
Project B:
Year Cash
flow
Present value
PV$1=1/(1+i)
n
Discounted
cash flow
Cumulative
discounted
flow
0 -
400000
1 -400000 -400000
1 100000 0.9091 90910 -309090
2 100000 0.8264 82640 -226450
3 100000 0.7513 75130 -151320
4 100000 0.683 68300 -83020
Discounted payback period= cannot be determine because the project end before the income
receive.
Project C:
Year Cash
flow
Present value
PV$1=1/(1+i)
n
Discounted
cash flow
Cumulative
discounted
flow
0 -
700000
1 -700000 -700000
1 200000 0.9091 181820 -518180
2 200000 0.8264 165280 -352900
3 200000 0.7513 150260 -202640
4 200000 0.683 136600 -66040
5 200000 0.6209 124180 58140
Payback period = 4 + (-66040 /124180)
= 4.53
Project D:
4

Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
Cumulative
discounted
flow
0 -614500 1 -614500 -614500
1 1,00,000 0.9091 90910 -523590
2 1,00,000 0.8264 82640 -440950
3 1,00,000 0.7513 75130 -365820
4 1,00,000 0.683 68300 -297520
5 1,00,000 0.6209 62090 -235430
6 1,00,000 0.5645 56450 -178980
7 1,00,000 0.5132 51320 -127660
8 1,00,000 0.4665 46650 -81010
9 1,00,000 0.4241 42410 -38600
10 1,00,000 0.3855 38550 -50
Payback period can’t be obtained
Project E:
Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
Cumulative
discounted
flow
0 -
5,00,000
1 -500000 -500000
1 1,20,000 0.9091 109092 -390908
2 1,20,000 0.8264 99168 -291740
3 1,20,000 0.7513 90156 -201584
4 1,20,000 0.683 81960 -119624
5 1,20,000 0.6209 74508 -45116
6 1,20,000 0.5645 67740 22624
7 1,20,000 0.5132 61584 84208
Payback period = 5 + (-45116 /61584)
= 5.73
5

Project F:
Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
Cumulative
discounted
flow
0 -
5,60,000
1 -560000 -560000
1 1,00,000 0.9091 90,910 -4,69,090
2 1,00,000 0.8264 82640 -3,86,450
3 1,00,000 0.7513 75,130 -3,11,320
4 1,00,000 0.683 68300 -2,43,020
5 1,00,000 0.6209 62,090 -1,80,930
6 1,00,000 0.5645 56450 -1,24,480
7 1,00,000 0.5132 51,320 -73,160
8 1,00,000 0.4665 46650 -26,510
9 1,00,000 0.4241 42,410 15,900
10 1,00,000 0.3855 38550 54,450
Pay back period= 8 + (-26,510 /38550)
= 8.68
Project G:
Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
Cumulative
discounted
flow
0 -
2,00,000
1 -200000 -2,00,000
1 1,00,000 0.9091 90910 -1,09,090
2 1,00,000 0.8264 82640 -26,450
3 80,000 0.7513 60104 33,654
4 80,000 0.683 54640 88,294
5 80,000 0.6209 49672 1,37,966
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6 80,000 0.5645 45160 1,83,126
Payback period= 2 + (-26,450 /45160)
2.58
b) Net present value for all projects
Net present value = present value cash inflow – present value of cash outflow over a period of
time
Project A:
year Cash flow Present value
PV$1=1/(1+i)
n
Discounted
cash flow
1 3,00,000 0.9091 272730
2 3,00,000 0.8264 247920
3 3,00,000 0.7513 225390
4 3,00,000 0.683 204900
5 3,00,000 0.6209 186270
6 3,00,000 0.5645 169350
Total 1306560
Net present value = 1306560 – 1000000
= 306560
Project B :
Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
1 100000 0.9091 90910
2 100000 0.8264 82640
3 100000 0.7513 75130
4 100000 0.683 68300
Total 316980
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Net present value = 316980-400000
= 83020
Project C:
Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
1 200000 0.9091 181820
2 200000 0.8264 165280
3 200000 0.7513 150260
4 200000 0.683 136600
5 200000 0.6209 124180
Total 758140
Net present value = 758140 – 700000
= 58140
Project D:
Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
1 1,00,000 0.9091 90910
2 1,00,000 0.8264 82640
3 1,00,000 0.7513 75130
4 1,00,000 0.683 68300
5 1,00,000 0.6209 62090
6 1,00,000 0.5645 56450
7 1,00,000 0.5132 51320
8 1,00,000 0.4665 46650
9 1,00,000 0.4241 42410
10 1,00,000 0.3855 38550
Total 614450
Net present value= 614450 – 614500
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= 50
Project E:
Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
1 1,20,000 0.9091 109092
2 1,20,000 0.8264 99168
3 1,20,000 0.7513 90156
4 1,20,000 0.683 81960
5 1,20,000 0.6209 74508
6 1,20,000 0.5645 67740
7 1,20,000 0.5132 61584
Total 584208
Net present value = 584208 – 500000
= 84208
Project F:
Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
1 1,00,000 0.9091 90,910
2 1,00,000 0.8264 82640
3 1,00,000 0.7513 75,130
4 1,00,000 0.683 68300
5 1,00,000 0.6209 62,090
6 1,00,000 0.5645 56450
7 1,00,000 0.5132 51,320
8 1,00,000 0.4665 46650
9 1,00,000 0.4241 42,410
10 1,00,000 0.3855 38550
Total 614450
Net present value= 614450 – 560000
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= 54450
Project G:
Year Cash
flow
Present value
PV$1=1/(1+i)n
Discounted
cash flow
1 1,00,000 0.9091 90910
2 1,00,000 0.8264 82640
3 80,000 0.7513 60104
4 80,000 0.683 54640
5 80,000 0.6209 49672
6 80,000 0.5645 45160
Total 383126
Net present value = 383126-200000
= 183126
c) Ranking the project according to payback period and net present value is:
Project Payback period Rank Net present
value
Rank
A 4.24 2 306560 1
B n/a 6 83020 4
C 4.53 3 58140 5
D n/a 6 50 7
E 5.73 4 84208 3
F 8.68 5 54450 6
G 2.58 1 183126 2
d) If the projects are mutually exclusive then the K plc will choose any one project out of two. In
the above case there are two mutually exclusive projects that are project A and G. The
organisation will separately invest in all the two project but will opt for that project whose net
present value is maximum in the current time. So in this case K plc will select Project A because
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the net present value of that project is 306560 although the Project G has the pay period which is
less than that of other one. If organisation need to select mutually exclusive project than the
decision are made by seeing the net present value(Watkins, 2020).
e) Strength and weakness of pay back periods and Net present value are (Gorshkov, and et. al,
2018):
Payback period:
Strengths Weakness
Speedy solution Ignore the time and money value.
Helpful in case of uncertainty Neglect cash flow receive after
payback period
Give preference to liquidity Not based on realistic approach
Simple to use Ignore profit
Net present value:
Strength Weakness
Verify investing value Future forecasting Error
Compute profitability Ignore the sunk cost
Identify the risk involved Depends upon the rate of discount
Can be adjusted according to the
condition
Cannot be used to evaluate projects of
dissimilar sizes.
e) The five qualitative factor that keeps in mind while making a firm decision are:
 Customers: Clients perception regarding the organization when they buy the goods and
services plays a very important role when the directors of the company made any
decision. How their problem is getting solved, the time taken to resolve the problem etc.
(Elliott, 2018).
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 External image: The top managers need to take in mind that hoe their decision will affect
the reputation of the company in outside the business environment.
 Employee relation: this is the most important factor. For all the organisation it is very
important to make any decision while seeing their engagement with the workforce
because they are the people who actual put efforts to enhance the production (Pinto,
2020).
 Technology outbreaks: technological advancement is one of the important factors. Before
passing any judgment the supervisor need to look after the technology so that they can
see if there is any outbreak because of this.
 Market share: Top managers need to properly analysis the market so that they can get to
know whether there is any market growth for the business and invest is made on this
factor Elwakil and Hegab, 2020).
TASK B
a) Three alternatives to raise capital for external sources are:
 Debt capital: Debt financing is that source to raise fund where the borrower issue some
debt securities from the bank. In this K plc will borrow some money from the bank in
exchange of some security. This source should be used as this one of the secure external
source through which capital can be gained in cheaper rate (Sohaib and et. al, 2019).
 Trade credit: This is nothing but a short term financing source were the credit is grant
by the creditors for certain period of time. This source should be suitable for K plc as it
will help them to delay their payment for certain period. The period of repayment
depends upon the agreement between the organisation and the provider.
 Factoring: This external source of funding will be best for K plc as it will help them to
raise the capital in short period. In this the debtors of K plc will be sealed to the third
party. The account receivables are being sale at the discount price. In this the purchased
that is also known as factor will accumulate the amount from the K plc debtors on behalf
of the organisation Lane and Milesi-Ferretti, 2018).
b) A link between the investment choice and the financial decision is called as Financial
planning. This planning process aims to identify the choice of the company in respect to the
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investment and thee sources to raise capital. The relationship between the two with Regard to K
plc is that it will help them to being the capital in the company. As the company in which they
are investing the capital help them to gain market share of that business to so that when they
diversified they will get the customer easily. This will also help to grow in the market and
capture more market share (Rodriguez-Satizabal, 2021).
TASK C
a) Total cost to be incurred for 1 unit = 3+2+30+18= 53
Total units produced in a year is 40000 * 53 = 2120000
To produced 9000 units in a quarter the cost incurred will be
= 9000 * 53 = 477000
Full variance analysis statement of variable cost will be follow:
Standard Actual
Direct labour 8500 *3 25500 29750
Direct material 18000 /2= 9000
*1
9000 18000
Direct labour 28000/3= 9333 *
30
280000 294000
Variable overhead 162500 165000
Total variable
production cost
477000 506750
So in the above table the cost to be incurred will be 477000 but the actual caot is 506750
So the overhead variable cost is 506750- 477000
= £29750
b) So from the above table it is identified that K plc is not utilising their resources effective way
due to which their cost of production in the first quarter is increased.
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 The direct cost that will be incurred for 8500 kg of S material will be 25500 but the actual
cost that is incurring is 29750 which means that for every they are paying £ 4250 extra
that means the turnover is high for producing material S.
 Next for direct material cost for T will be 9000 for every 2 kg but there are paying £ 1 for
every 1 kg that means actual they are paying £18000. This indicates that they are paying
double to procure material T.
 Direct labour cost will be for every 1 hour they will be pay £ 10 so if the labour work for
28000 so they will be paying 280000 but they are paying extra 294000. £ 14000 is being
paying extra for 1400 hour work.
 Variable overhead will be £ 162500 but they are incurring cost £165000.
 So in total they are paying extra £ 29750 in the first quarter.
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TASK 4
Comparison between centralised and decentralised procurement and their benefits.
Centralised and decentralised purchasing are two type of organisation composition. These
type can be found in the company, government bodies and even when the procurement are been
made. The term centralised itself says the authority to take decision or plans are only in the hand
of top managers of the company whereas decentralised means authorities are being delegated to
the other department mangers to take decision based on their departmental needs. All the power
in centralised are at apex stage , in other hand Decentralised means diffusion of power to
subordinate also (Oehler, and et. al, 2018).
Centralised purchasing:
Centralised purchasing means all the procurement are been done at the central stage of the
company. If department need any material than they need to inform the fundamental authority
and the purchase is made by them according to the needs. This type of procurement of material is
possible when there is only one plant of the organisation. This will help them to buy in economic
quantity and also avoid of purchasing in the tiny lots. The whole procurement authority is made
in one hand that is the purchasing department. As the material is purchased in large quantity this
will help in favourable price for buying and the economy of scale. This also helps in managing
the raw material in effective and efficient manner(Shah, Ahmad and Mahmood, 2018).
There are some benefits of centralised procurement:
 Bulk buying discount: Centralised purchasing help the organisation to bargain in
effective manner as the order is made in large amount which help them to negotiate for
discount as buying is made in bulk.
 Wider supplier network: The procurement is made by the purchasing department which
help them to extend their supplier network to the local buyers. This will benefit them by
getting the material at the lowest price will analysing the provider.
 Single Centralised store: As the company is situated at small area where operating cost is
incurred on one geographical area so managing one single store is easy. It will also help
the purchasing department to maintain their inventory in effective way rather than
distributing it on several parts. This will also provides access to information about the
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stock which is in bulk and which required on the urgent basis (Harrison, Rafiq and
Medcalf, 2018).
 Effective Quality: One of the important advantages in centralised purchasing is that it
provides quality raw material as organisation will easily contact with those supplier who
gives prime material.
Decentralised purchasing:
This is just the opposite of centralised purchasing. When the company has so many planets in
different location then this type of structure is been followed so that complexity can be increased.
Various purchasing agents are there who buy the raw material according to the need of their
planet. Decentralised purchasing means procuring the material by the subordinate who has assign
the power of delegation. Decentralised purchasing is also known as local purchasing. This is
flexible approach when there is so many subsidiary of the big organisation. Here the authority to
take declension are been delegated by the head department so that complexity of providing stock
to different location can be solved in effective and efficient manner. The raw material
procurement is made by the purchasing department on the basis of the local needs and want and
the planet does not rely to the head to conduct their business activities (Khoukhi, Bojji and
Bensouda, 2021).
Following benefits of centralised purchasing are:
 Reduce burden on top mangers: Where there is so many subsidiary of the company
than the burden to top management increases. So decrease that burden the purchasing
agents are being hired for various location so that top executive can perform their
function in effective manner. Decision are made very fastly by the decentralised structure
so that uncertainty can be avoid.
 Better control and supervision: Decentralisation purchasing promotes amended control
and supervision as the inferior has the power to take decision independently. They do not
relay on the higher authority for the problem that require immediate solution. This also
boosts the morale of the employee (Moretto and et.al, 2020).
 Facilitates diversification: The most important benefits are it promotes diversification.
It will help the variation of goods and services according to the market. This
diversification is not possible in Centralised procurement. They also have the advantage
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were they can purchase raw material from the diversified suppliers located at different
parts.
The decentralised procurement is better option when they want purchase in localized industry
or when there are different branch mangers (Ellul, 2021).
.
CONCLUSION
From the above report it is been concluded that to run the business it is very important to
manage their finance. Without effective funds company cannot utilise their resources in effective
and efficient manner. This report consist of four task, the first task talks about the payback period
and the net present value for the different project that is adopted by K plc. They also talks about
the strength and weakness about the two. In K plc there is two mutually exclusive projects and
the director will select which has more present value. The second parts tell about the various
external sources that is available to raise capital for diversification. The third task of the report is
all about the variable cost. The K plc has variable overhead which means that company is not
using their capital in effective and efficient manner. The last task is all about the centralised and
decentralised procurement and the benefits of all the two structure. In centralised purchasing the
procurement of the material is done by the central authority whereas in decentralised power is
delegated to various purchasing agents of different subsidies, which means that purchasing is
made according to the store purchasing department of the single organisation.
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