Capital Budgeting Techniques and Long-Term Financing for S Plc

This report discusses various capital budgeting techniques such as cash-flow analysis, payback period, net present value, internal rate of return, and their importance for S Plc. It also critically contrasts bank loan with equity issue in long-term finance, calculates break-even sales revenue, and discusses the assumptions of cost-volume-profit analysis. The report is based on S Plc which deals in computer games and wants to broaden its product line.

Business Report

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
TASK...............................................................................................................................................3
A.......................................................................................................................................................3
1. Explaining the importance of capital appraising process........................................................3
2. Calculating cash-flow analysis statement...............................................................................3
3. Calculating Payback period.....................................................................................................4
4. Determining Net Present Value for new investment...............................................................5
5. Explaining logic behind Net present value and relationship to cost of capital.......................5
6. Computing Internal Rate of Return and its impact on investment..........................................6
7. Discussing the superiority of NPV than IRR..........................................................................6
B.......................................................................................................................................................7
Critically contrasting bank loan with equity issue in long-term finance....................................7
C.......................................................................................................................................................8
1. Calculating break even sales revenue.....................................................................................8
2. Calculating the changes in BEP if prices changes..................................................................8
3. Discussing the assumption of Cost-volume-profit analysis....................................................9
D.....................................................................................................................................................10
1. Explaining the difference between three categories of suppliers..........................................10
2. Comparing the advantages of single-sourcing and multiple sourcing..................................11
3. Describing Cross-sourcing with example and benefits.........................................................12
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................14

INTRODUCTION
Capital investments require lot of funds by company so that it can enhance its business
operations and can achieve higher goals and objectives. It can be done through various sources
such as raising a loan or equity shares, utilizing company's retained earnings, etc. The present
report is based on S Plc which deals in computer games and wants to broaden its product line.
The study will outline various techniques of capital budgeting which can be used by organization
to analyse profitability of proposal.
Further, the report will highlight the contrasting views on equity issue and bank loans. It
will also calculate break even sales revenue and will provide useful insight about cost-volume
profit analysis. In addition to this, report will also distinguish between different categories of
suppliers and will compare single source and multiple sources of procurement. Lastly, study will
explain cross-sourcing along with example and its benefits to buyers.
TASK
A
1. Explaining the importance of capital appraising process
 Evaluating the capital investment with different techniques helps company identifying the
optimum proposal that will give company maximum output with minimum input and
risks.
 Large amount of money is invested in capital resources that makes it necessary for S Plc
to analyse investment proposals in depth (Alles and et.al., 2021).
 Investment decisions are linked to S Plc's strategic business decisions that have direct
impact on shareholders' wealth. Therefore, to maximize shareholders' wealth capital
decisions are important if taken with the help of different techniques.
 S plc is involved with no. of long term investment proposals which leads to greater risks
than return. In such case, cash flows may be affected badly. Hence, capital appraisal is
beneficial for business entity.
2. Calculating cash-flow analysis statement
Initial Investment
Particulars Amount (£)

Production equipment 1000000
Staff training provision 100000
Advertising & promotion costs 20000
Incremental working capital 180000
Total 1300000
Cash Inflow
Year Amount (£)
1 600000
2 1000000
3 1200000
4 1000000
5 800000
total 4600000
Cash Outflow
Particulars Year 1 Year 2 Year 3 Year 4 Year 5
Cost of sales 180000 300000 360000 300000 240000
Operation costs 100000 100000 100000 100000 100000
Depreciation 260000 260000 260000 260000 260000
Total 540000 660000 720000 660000 600000
Cash-flow statement
Year Cash inflow Cash outflow Net Cash flow
1 600000 540000 60000
2 1000000 660000 340000
3 1200000 720000 480000
4 1000000 660000 340000
5 800000 600000 200000

3. Calculating Payback period
Year Cash flow Cumulative cash flow
1 60000 60000
2 340000 400000
3 480000 880000
4 340000 1220000
5 200000 1420000
80000
0.4
Payback Period 4.4 years
The payback period for new investment is of 4.4 years which means the project will take
4 years and 4 months to return the initial outlay. S plc should not accept this proposal if it is
imposing 3 year pay-back because the project will take more than 4 years to return the principal
amount.
4. Determining Net Present Value for new investment
Year Cash flow PV factor Discounted Cash flow
1 60000 1.02 61200
2 340000 1.04 353736
3 480000 1.06 509379.84
4 340000 1.08 368026.93
5 200000 1.10 220816.16
Total 1513158.94
initial investment 1300000
Net Present Value £213158.94
The investment proposal should be accepted by S plc because it is positive, that is,
£213158.94 which depicts that all cash inflows are more than outflows over the life of
investment. If NPV is greater than zero, the investment should be accepted. Net Present value
method takes into consideration all expenses, capital costs, and revenues associated with project.
This method proves to beneficial because it takes time value of money into account and adjust
the risks of the project (Gafli and Daryanto, 2019).

5. Explaining logic behind Net present value and relationship to cost of capital
Net present value technique measures the efficiency and profitability level of investment
and evaluates whether organization should invest in the project or not. NPV makes use of
discounted cash flows in the evaluation which precisely considers risk and time component.
Project should be independent which means it should not be affected by cash flows of other
projects and it should produce positive NPV for acceptance of proposal (Chrysafis and
Papadopoulos, 2021).
Cost of capital is the least desired rate of return which is a weighted average cost of
equity and debt. If the expected cash outflow are more than cash inflows, then NPV is negative
i.e. less than zero. In the case, project proposal is rejected by company. On the other hand, if
expected outflows are less than inflows, then Net present value is greater than Zero which means
it is positive. Investment proposal is accepted because it is giving positive cash flows.
6. Computing Internal Rate of Return and its impact on investment
Year Cash flow
0 -1300000
1 60000
2 340000
3 480000
4 340000
5 200000
Internal rate of return 2.81%
With given cost of capital at 20%, the investment is providing just 2.81% of return which
is very less than cost of capital. Though, project is giving return of 2.81% but it is not covering
the cost of capital to a large extent. Therefore, S Plc should not accept this project because of its
lower rate of return.
Change in cost of capital affect the IRR because IRR is compared with cost of capital
before making a decision. Even if cost of capital is reduced to 10%, IRR will remain at 2.81%
only which is also less than changed cost of capital. Therefore, a change in capital cost will make
the proposal rejected only.

7. Discussing the superiority of NPV than IRR
There are various situations that causes problems for IRR, one of which is it does not
consider changing discount rates which is not suitable to evaluate long term profitability of
venture. The discount rate does not remain constant and keep on changing substantially over
time. The benefit of using NPV is that it take into account multiple discount rates without any
issues. Cash flows can be discounted every year separately without any problem (Difference
Between NPV and IRR, 2021).
Another problem with IRR is that it is ineffective when there are many positive and
negative cash flows due to market conditions. Therefore, long-term ventures with changing cash-
flows will lead to multiple and distinct IRR. On the other hand, NPV can be used to analyse long
term projects or merger and acquisitions that will be favourable for company.
In addition to this, decision taken in case of IRR is based on percentage basis and it does
not clearly states how much return will generated to business whereas NPV shows outcome in
dollar or pound which serves to be better to take final investment decision (Basu, 2019).
B
Critically contrasting bank loan with equity issue in long-term finance
Long-term finance means raising funds or money from financial instruments that have
maturity period of more than one year such as bank loans, leasing, issuing bonds and debentures
and equity issues. S Plc has a choice whether to go for debt financing or equity one, the choice of
which depends upon easy accessibility, cash flows, maintaining company control, etc.
Debt financing in terms of taking a bank loan is more beneficial to S Plc because debt is
cheaper than equity in long term. When company plans to scale up its operations and grow its
business then Debt is better than equity because in equity it involves selling of a part of company
to venture capitalist (Legesse and Guo, 2020).
Furthermore, raising funds from debt will help S Plc in having some tax perks which is
not available in equity financing. The interest payments which are included in profit and loss
account decreases the net taxable income. So, effective cost of debt is much less than mentioned
interest rate.
Another favourable point of debt financing is that the lender will not explain the business
about how to operate in industry. The equity holders have a right to participate in businesses by

giving them seats on board. Money lender to business does not bother how S Plc is working, they
just want their interest payments on time.
In addition to this, debt financing can be useful if company is having continuous revenue
streams which means a small part of loan will enhance cash flows and extra cash in hand will
allow to company to make fresh recruitment. The new hires will come up with effective sales
programs and schemes which will further enhance the ROI (Debt vs Equity Financing, 2021).
Along with this, raising funds through equity is a lengthy and time-consuming process
which involves long meeting with venture capitalists, drawing up legal documents and
paperworks, etc. On the other hand, raising loans generally takes lesser time, say a month and
does not involve several meetings (Vaznyte and Andries, 2019).
Moreover, debt financing comes with definite term and conditions with little alteration in
coming years. The interest payment amount remain constant every month with no fluctuations as
compared to dividends payments which changes every year with change in profits.
C
1. Calculating break even sales revenue
Break-even sales revenue
Particulars Amount per unit (£)
Selling price per unit 100
Variable cost per unit 60
Contribution margin 40
Break even point 7500
BREAK EVEN SALES 750000
Sales revenue to achieve a target profit of £120,000
Desired profit 120000
Contribution per unit 40
Break even units 7500
No. of units to produce desired profit 10500
Sales revenue £1050000

Margin of safety
MOS = Sales revenue - break-even sales
= 1050000 - 750000
= £300000
2. Calculating the changes in BEP if prices changes
If the selling price per game is increased by 10% i.e. £110, the changes in break even sales is as
follows:
Particulars Amount per unit (£)
Selling price per unit 110
Variable cost per unit 60
Contribution per unit 50
Fixed cost 300000
Break even point 6000
BREAK EVEN SALES £660000
Desired profit 120000
Contribution margin 50
No. of units to produce desired profit 8400
sales revenue 924000
Margin of safety £264000.00
If SP is reduced by 10% that is, £90 the changes in BEP is as follows:
Particulars Amount per unit (£)
Selling price per unit 90
Variable cost per unit 60
Contribution per unit 30
Fixed cost 300000
Break even point 10000
BREAK EVEN SALES £900000
Desired profit 120000
Contribution margin 50

No. of units to produce desired profit 8400
Sales revenue 924000
Margin of safety £264000.00
3. Discussing the assumption of Cost-volume-profit analysis
The cost-volume-profit analysis basically known as break even analysis calculates break
even point for sales volumes which helps the company in framing short-term decisions. CVP is
used so that economic justification of producing a product can be identified.
Critically commenting on assumption of CVP:
 First assumption of CVP is that all major costs are divided in two categories, that is, fixed
and variable costs. It is not always true that there are only two costs, there are other cost
also such as semi-variable cost, for example, telephone expense. There are other cost also
such as depreciation cost which is not determined exactly.
 Secondly, fixed costs remain same at all levels of sales which does not hold true in all
conditions. Sometimes, fixed cost also changes to a small extent with the changes in
production levels. It does not take into account the changes due to inflation or economic
conditions.
 Next, selling price remains constant which is not correct in competitive world because
prices of a product changes with the changes in market trends and sometimes
organisation changes its pricing policy also which affects CVP.
 Another assumption is that only no. of units produced will affect total cost and revenue.
However, it is not true because variable costs is affected by bulk order quantities which is
not considered while calculating total variable expense (Common Assumptions in Cost-
Volume-Profit (CVP) Analysis, 2021).
 It also assumes that total production volume is sold within a particular period which also
does not hold true. Reason being it is not necessary that whatever produced can be sold
within stipulated time. Sometimes, it takes more than a year to turn inventory into sales
and many a times product is not sold because it has become outdated.

D
1. Explaining the difference between three categories of suppliers
Strategic Suppliers Preferred Suppliers Transactional Suppliers
They have long-term and
intense relationship.
These suppliers have
operational and ongoing
relationship.
They are basic vendors and
have tactical and transactional
relations.
In this type of suppliers,
alternatives exist but
resourcing it would result in
above average cost.
Here, alternatives exist and
resourcing results in average
cost.
In this case also, alternatives
exist and resourcing them will
affect only routine cost.
Such suppliers are key
suppliers of business (Demirel,
Kapuscinski and Yu, 2018).
They are less strategic than
key suppliers.
Transactional suppliers are
non-strategic suppliers.
Original equipment
manufacturing leads to
dependence on strategic
suppliers which cannot
purchased anywhere else.
Business is not dependent on
these suppliers and source
them only if performance is up
to the mark.
Here, business is not
dependent on these suppliers
(Lechner, 2019).
Businesses share complete
information about their plans
and policies with strategic
suppliers.
A little information is shared
with these suppliers.
Hardly, any information about
company is shared with
transactional suppliers.
Strategic suppliers are vital for
business and have high impact
and value in achieving long
term goals.
These suppliers have financial
impact on business process
and profit margins.
The transactional suppliers do
not have any impact on
business process and company
can replace these suppliers at
any point of time.

2. Comparing the advantages of single-sourcing and multiple sourcing
Single-sourcing strategy is a strategy where all the purchase orders are given to single
supplier. A regular purchase In bulk quantities from a single supplier benefits the firm to save
costs and maintain the level of quality of goods.
Multiple-sourcing is strategy where a large no. of suppliers are tapped to get resources to
fulfil business needs. The economy is growing at a faster pace which provides ample of
opportunities to business to procure goods from more than one supplier
Advantages of Single-source:
 When large quantities are purchased from supplier, it creates a win-win condition for
buyer and seller with increased commitment, cooperation & communication. It fosters
deeper relations between company and supplier which results in fast delivery of goods
without compromising on quality.
 Procurement of goods from single seller results in long term contracts and decreases
uncertainty to lose business on supplier part.
 When long term contracts are made, supplier easily invests in new machine and
equipments or changes its operating techniques to adjust with buyer needs.
 Single sourcing leads to better visibility of operational process and detection of any
mistakes easily. Business can also provide quick feedbacks to improve product quality.
 Buying from single supplier helps in reducing cost and availing economies of scale
because of easy negotiation of prices with seller. It also saves time and energy because company do not have to meet and decide
quotations with several providers in market. This type of strategy also results in less
administrative work, reduced paperwork and maintains easy accounting systems (Ivanov,
2017).
Advantages of Multiple-sourcing:
 Buying goods from multiple sources will result in lower costs and enhanced quality
because of competition among suppliers. It can also lead to bidding war for a particular
contact which will lower the prices.
 There is a continuous supply of products because in case of any strike or natural disaster,
the other supplier can deliver products without any disturbances in production process. It

means there is no dependence on one supplier to supply goods which enhances the
freedom of company (Rashidi and Cullinane, 2019).
 Multiple sourcing is advantageous in case of high demand of products. Maintaining
relations with several vendors will result in continuous supply without interruptions to
meet increasing customer demand and satisfy consumer needs.
 It is very to easy to replace any supplier because of presence of several vendors without
affecting the contracts and business of organization. If one supplier increases its prices,
organization can easily shift to another vendor with lower quotations.
3. Describing Cross-sourcing with example and benefits
Cross-sourcing:
A sourcing strategy used by businesses where a single provider supplies on part or
administration and other provider provides alternate part with same capacities. It is a hybrid
approach of single sourcing and multiple sourcing because organization can procure products
from single or multiple vendors (He and et.al., 2018).
For example, there are 2 suppliers, Supplier X and Supplier Y. Both suppliers can
produce parts a, b, c, d and e with same capacities. Now, company can make use of cross-
sourcing and can benefit from it. Suppose Supplier X produces all parts of a, c and e while
supplier Y manufactures all of b and d. if anything happens bad like strikes or disasters to
supplier X, then supplier Y can continue with production because it has the capacity to produce
a, c & e as well.
Benefits:
 Cross-sourcing helps in procuring product easily without any disruptions in production
cycle in case of any natural disaster.
 Any supplier who is not meeting the company expectations, providing goods at poor
quality and high prices can be changed easily without any issues.
 It reduces the risk of non-availability of goods because if one supplier fails to supply
products, other suppliers can be approached for supplying goods.
CONCLUSION
From the above report, it can be summarized that capital budgeting techniques are
important to evaluate the efficiency of investments. It helps in selecting that project which has

maximum benefit with the least risk. It can also be concluded that NPV is a better method for S
plc to evaluate the profitability of new investment than others because it considers discounted
factor and time value of money that other methods ignore it. Another conclusive point is that
NPV is better than IRR because IRR provides the result in percentage format which becomes an
obstacle to correctly estimate the profitability of venture.
Furthermore, it can be analysed that debt financing is better than equity in long term
because loans and advances comes with definite terms and conditions with little alterations as
compared to equity. The study has also shed light on different types of suppliers along with their
relations with company. Report also described the advantages of single-sourcing and multiple
sourcing. Single sourcing leads to improved supervision over performance because only one
vendor is considered here as compared to multiple suppliers.

REFERENCES
Books and Journals
Alles, L. and et.al., 2021. An investigation of the usage of capital budgeting techniques by small
and medium enterprises. Quality & Quantity. 55(3). pp.993-1006.
Basu, U. K., 2019. CAPITAL BUDGETING TECHNIQUE FOR BORROWING
PROJECTS. Hyperion International Journal of Econophysics & New Economy. 12(2).
Chrysafis, K. A. and Papadopoulos, B. K., 2021. Decision making for project appraisal in
uncertain environments: A fuzzy-possibilistic approach of the expanded NPV
method. Symmetry. 13(1). p.27.
Demirel, S., Kapuscinski, R. and Yu, M., 2018. Strategic behavior of suppliers in the face of
production disruptions. Management Science. 64(2). pp.533-551.
Gafli, G. F. M. and Daryanto, W. M., 2019. Decision making on project feasibility using capital
budgeting model and sensitivity analysis. case study: Development solar PV power plant
project. International Journal of Business, Economics and Law. 19(1). pp.50-58.
He, Y. and et.al., 2018. An in-depth analysis of contingent sourcing strategy for handling supply
disruptions. IEEE Transactions on Engineering Management. 67(1). pp.201-219.
Ivanov, D., 2017. Simulation-based single vs. dual sourcing analysis in the supply chain with
consideration of capacity disruptions, big data and demand patterns. International Journal
of Integrated Supply Management. 11(1). pp.24-43.
Lechner, G., 2019. Supplier Relationship Management: Small, Non-Replaceable Suppliers and
Close Customer-Supplier Relationships. Open Journal of Business and Management.
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Legesse, T. S. and Guo, H., 2020. Does firm efficiency matter for debt financing decisions?
Evidence from the biggest manufacturing countries. Journal of Applied Economics. 23(1).
pp.106-128.
Rashidi, K. and Cullinane, K., 2019. A comparison of fuzzy DEA and fuzzy TOPSIS in
sustainable supplier selection: Implications for sourcing strategy. Expert Systems with
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Vaznyte, E. and Andries, P., 2019. Entrepreneurial orientation and start-ups' external
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Online
Common Assumptions in Cost-Volume-Profit (CVP) Analysis. 2021. [Online]. Available through:
<https://www.assignmentpoint.com/business/accounting/common-assumptions-in-cost-
volume-profit-cvp-analysis.html>
Debt vs Equity Financing. 2021. [Online]. Available through:
<https://corporatefinanceinstitute.com/resources/knowledge/finance/debt-vs-equity/>

Difference Between NPV and IRR. 2021. Common Assumptions in Cost-Volume-Profit (CVP)
Analysis.[Online]. Available through: <https://www.wallstreetmojo.com/npv-vs-irr/>