2Capital Budgeting Table of Contents Computation of Payback Period and NPV:................................................................................3 Project Appraisal:.......................................................................................................................3 Net Present Value (NPV):..........................................................................................................3 Payback period:..........................................................................................................................4 References and bibliography:.....................................................................................................6
3Capital Budgeting Computation of Payback Period and NPV: Project Appraisal: From the above analysis, it can be observed that, the project is having a negative net present value of $135,058 considering a discounting rate of 10%. Therefore, the project may cause capital erosion rather than a capital accumulation. Therefore, it can be suggested not to accept the proposed project. The project is having an internal rate of return of 3.56% where as the cost of capital is 10%. Hence, from the view point of return also, the project should not be accepted, as the internal return of the project is less than the cost of capital. Net Present Value (NPV): Net present value is the measure of profitability in terms of present value of future expectedrevenues.Everyprojectrequirescertainamountofinvestmentinitially.In
4Capital Budgeting subsequent years, also certain amount of expenses might be required as an additional investment (Baum& Crosby, 2014). Before making any investment, in any project or investment opportunity, a feasibility and profitability analysis must be conducted. Net Present Value (NPV) is such a project appraisal technique, which can be applied for understanding whether the investment opportunity will have a capital appreciation or capital erosion. To compute net present value, all the future expected net cash flows are discounted with a suitable discounting rate, and then the initial investment amount is deducted from the sum of future cash flows. If the difference is negative then it is called a negative NPV and if the difference is positive then it is called a positive NPV. The acceptance criteria for the net present value techniques is to accept the investment proposal if the NPV is positive and if the NPV is negative then it is suggested to reject the investment proposal. If there are multiple investment options, then the project with the highest NPV should be selected. In the given case study, the New Café is having a negative net present value, which implies capital erosion. Hence, the investment project should not be accepted (Baum & Crosby, 2014). Payback period: Payback period is another method of project appraisal. It is a non discounted technique where the time period of the investment recovery is considered for the project appraisal. Payback period is the time in which the initial investment is recovered back from the revenue generation of the project (Alkaraan, 2015). It means the time the project takes to pay back the initial investment from the profit earned. Acceptance criterion for the payback period method is to accept the project with the lowest payback period. In the given case study of the New Café, the investment project is having a payback period of 4.51 years. The policy of the company is to accept such investment options having a payback period within 3 years.
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5Capital Budgeting Hence, the new investment project for the New Café should be rejected as the payback period of the investment option is more that their desired payback period (Alkaraan, 2015).
6Capital Budgeting References and bibliography: Alkaraan, F. (2015). Strategic investment decision-making perspectives. InAdvances in mergers and acquisitions(pp. 53-66). Emerald Group Publishing Limited. Alkaraan,F.(2017).Strategicinvestmentappraisal:multidisciplinaryperspectives. InAdvances in Mergers and Acquisitions(pp. 67-82). Emerald Publishing Limited. Baum, A. E., & Crosby, N. (2014).Property investment appraisal. John Wiley & Sons. Illés, M. (2019). Links Between Net Present Value and Shareholder Value from a Business Economics Perspective.