Business Decision Making: NPV, Payback Period, and Factors

This essay explores the concept of business decision making, focusing on the implementation of investment appraisal techniques such as NPV and Payback period. It includes a case study of ABC Plc and analyzes the financial and non-financial factors involved in the decision-making process.

Essay on business decision
making

Contents
ESSAY TOPIC................................................................................................................................1
INTRODUCTION...........................................................................................................................1
ESSAY BODY................................................................................................................................1
Net present value including its benefits and drawbacks..............................................................1
Payback period including its benefits and drawbacks.................................................................3
Financial and non-financial factors.............................................................................................4
CONCLUSION................................................................................................................................4
REFERENCES................................................................................................................................5

ESSAY TOPIC
“An understanding on business decision making including NPV & Payback period, and
financial & non financial factors used in decision making process”
INTRODUCTION
Business decision making is a concept of making viable and informed decisions in an
organisational structure. This concept assists an organisation to be profitable and able to achieve
its objectives. The main aim of this essay is to build an understanding about the implementation
of investment appraisal techniques such as NPV and Pay back period. For this purpose, a case of
ABC Plc is selected which is seeking advice for appropriate investing decision. In this essay,
NPV and Payback period is computed along with analysis of financial and non-financial decision
making factors.
ESSAY BODY
ABC Plc is a growing company which trades in the region of United Kingdom and plans to
expand the business. In order to ensure the smooth functioning of the operations, the company
has decided to invest in a new project. The most effective two projects are shortlisted which are
motor software project and hardware project which are compared using their suitability checked
through NPV and Payback period. Initial investments of both the projects is £40000 and £60000
respectively and the company’s rate of return is 12%.
Net present value including its benefits and drawbacks
Net present value is a technique in which all the net cash flows of a company are
discounted in order to account value of time to calculate the profit which an organisation will
earn against the investment in a certain project (Weygandt and et.al., 2018). The benefits of
technique are that it helps in considering the risk factors which company may face in future and
it helps in analysing the opportunity cost of alternative projects. Like any other financial metric,
this technique also has few limitations which includes requirement of professional skills and
considerate time which makes it difficult to use for small scale companies.
For ABC Plc., NPV calculation is done below, which can provide them a benefit of
consideration of contingent factors:
PROJECT A: Motor Software Project
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Year Net cash
flow (A)
PV factor
Calculation
PV factor @
12% (B)
Discounted cash
flow (A*B)
1 8000 1/(1+0.12) 0.892857143 7142.857143
2 12000 1/(1+0.12)^2 0.797193878 9566.326531
3 16000 1/(1+0.12)^3 0.711780248 11388.48397
4 20000 1/(1+0.12)^4 0.635518078 12710.36157
5 30000 1/(1+0.12)^5 0.567426856 17022.80567
Total discounted
cash flow 57830.83488
Less: initial
investment (0) 40000
Net Present
value 17830.83488
PROJECT B: Hardware Project
Year Net cash
flow (A)
PV factor
Calculation
PV factor @
12% (B)
Discounted cash
flow (A*B)
1 10,000 1/(1+0.12) 0.892857143 8928.571429
2 20,000 1/(1+0.12)^2 0.797193878 15943.87755
3 25,000 1/(1+0.12)^3 0.711780248 17794.5062
4 30,000 1/(1+0.12)^4 0.635518078 19065.54235
5 40,000 1/(1+0.12)^5 0.567426856 22697.07423
Total discounted
cash flow 84429.57176
Less: initial
investment (0) 60000
Net Present
value 24429.57176
From the above analysis, it can be observed that Project A which has the initial,
investment of £40000 is capable of earning NPV of £17830 after the usage period of five years.
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On the other hand, project B is capable of earning £24429 of NPV. This evaluation provides a
clarity that project B is much more effective than project A.
Payback period including its benefits and drawbacks
Payback period is a technique which calculates the time period in which a company can
recover its initial investment against a project. This method provides a clear measure for
comparison (Wu and Law, 2016). Benefits of this technique includes its easiness, less
complexity and quick procedure which will help ABC Plc. to make quick decisions regarding
which project is more beneficial for them. There are few limitations of this technique as well
which are it ignores the time value of money and it does not account for risk of contingencies
which company may have to face in future.
In order to make a decision about which project is better, payback period computation for
ABC Plc is presented below:
PROJECT A: Motor Software Project
Year Net cash flow Cumulative Cash Flow
1 8000 8000
2 12000 20000
3 16000 36000
4 20000 56000
5 30000 86000
Initial investment - £40,000
Recovered amount in 3 years - £36,000
Difference amount - £4,000
Payback period = 3 + (4000 / 20000 * 12)
= 3 + 2.4
= 3 years and 2.4 months
PROJECT B: Hardware Project
Year Net cash flow Cumulative Cash Flow
1 10,000 10000
2 20,000 30000
3 25,000 55000
3

4 30,000 85000
5 40,000 125000
Initial investment - £60,000
Recovered amount in 3 years - £55,000
Difference amount - £5,000
= 3 + (5000 / 30000 * 12)
= 3 + 2
= 3 years and 2 months
It is evident that project B of hardware is more appropriate for ABC Plc.
Financial and non-financial factors
Financial factors are the influencers related to economic environment of a business. For
ABC Plc., financial factors impacting the functioning of operations are economic stability of
United Kingdom, interest rates, taxation policies and many more. Economic stability of UK is
sound due to which ABC can pursue their plans for expansion (Schwartz, 2017). For the purpose
of initiating a project of hardware, company will require funds which will be procured by loans
on interest needs to be paid. The average interest rates in ABC are low due to which company
can easily procure 60000 initial investments for their project B.
Non financial factors which can help in decision making is future legislations. The laws of
UK are rapidly changing due to BREXIT due to which company should select a project with low
risk factors (Eijdenberg, Paas and Masurel, 2017). These non financial factors also indicate that
project B of hardware is much appropriate choice of this company at this stage.
CONCLUSION
From the above essay, it has been concluded that NPV and Payback period are suitable
techniques for business decision making. From the financial analysis of ABC Plc., it has been
found that company should invest in project B of hardware as it will result in more profits and as
the interest rates of UK are low, company will be able to easily procure such initial investment
value.
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REFERENCES
Books and Journals
Eijdenberg, E. L., Paas, L. J. and Masurel, E., 2017. Decision-making and small business growth
in Burundi. Journal of Entrepreneurship in Emerging Economies.
Schwartz, M. S., 2017. Business ethics: An ethical decision-making approach. John Wiley &
Sons.
Weygandt, J. J. and et.al., 2018. Managerial Accounting: Tools for Business Decision-making.
John Wiley & Sons.
Wu, L. and Law, S., 2016. A practical approach to teach graduate students to write persuasively
for business decision making.
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