Financial Management : Sample Assignment

FINANCIAL MANAGEMENT
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Executive summary
The following report contains detailed report on capital budgeting decisions. It includes
qualitative and quantitative analysis on decision making analysis for a company. When the
management has limited resources, it is required to make decisions so that maximum benefits
from the same can be gained. In given scenario we have first analysed the financial viability
of production of Q-Power boats, and further comparison between the production of Q-power
boats or s-power boats. The decision have been made based on capital budgeting tools such
as net present value, internal rate of return and pay-back period.
The cash flows used in the analysis are based on detailed market survey. The company is
expected to opt for best available option. Use of capital budgeting techniques will help the
management take appropriate decision.
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Contents
1. Introduction........................................................................................................ 4
2. Findings............................................................................................................. 5
2.1 Quantitative....................................................................................................... 5
Net Present Value................................................................................................. 5
Pay-back period.................................................................................................... 5
Internal rate of return............................................................................................. 6
2.2 Qualitative........................................................................................................ 6
3. Recommendation and justification.............................................................................8
4. Detail Comparison and further Recommendation...........................................................9
5. Conclusion........................................................................................................ 10
Bibliography............................................................................................................ 11
Appendix................................................................................................................ 12
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1. Introduction
Capital budgeting decision is one of the most widely used decision making tool. We are
provided with a decision making case for a company PENTAG, in which the management is
to take important decision regarding production of one or other type of product. In our
discussion in the below report, we have implement qualitative and quantitative research on
the options available with the company. Based on both the aspects the company is required to
the final decision.
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2. Findings
2.1 Quantitative
The company has the option of producing Q-powerboats. The management of the company
after detailed study has been able to collect financial data on the expected cash flows of the
company. We have conducted capital budgeting technique in respect to this proposal in order
to come to conclusion on financial viability of the project.
Net Present Value
We have calculated the net present value of the said project. Net present value is the capital
budgeting tool under which the difference between the present values of cash outflows are
deducted from present value of cash inflows (Adelaja, 2015). This represents the excess
cash flow earned over invested amount. If the amount is positive then the project seems
viable and should be accepted, but if the project NPV is negative it should be rejected. NPV
is calculated using the following formula:
The net present value of the investment opportunity for PENTAG for production of Q-Power
board with a required of 20% resulted in $5812640. This indicates that the project is likely to
generate value for the company. Based on these calculations, the project is expected to create
value for the company and should be accepted.
Pay-back period
Pay-back period is the capital budgeting tool that helps the investor determine the time period
within which the invested amount in a project will be recovered (Bierman & Smidt, 2010).
For example, we have a project with life of 5 years, which requires 10000 investments in the
beginning, the pay-back period will calculate the time span within which this invested
amount of $ 10000 will be recovered from the cash flow of the project. Pay-back period is
calculated using the following formula:
Pay-back
period = a+(b/c)
Where,
A = the period with last negative cumulative cash flow
B = the amount of last cumulative cash flow
C = the cash flow just after the period a
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The pay-back period of the said project amounted to 2.53 years. The required pay-back for
this project by the management is 4 years. Therefore, we see that the company will recover its
invested amount before its required time. Based on this the project seems worthy of
acceptance.
Internal rate of return
Internal rate of return is the hidden rate of return that is actually earned on the project. The
internal rate is calculated by equating the cash outflows and inflow, then using the method of
trial and error the hidden rate of return in calculated (Datar, 2016). If IRR is more than the
required rate of return then the project should be accepted and if it is lower than it should be
rejected. For the given project of production of Q-Powerboats the internal rate of return is
31%. Since the IRR is more the required return the project should be accepted.
2.2 Qualitative
Besides the financial aspects, there are other qualitative factors also which the company
should take into consideration before accepting a new project. (Seitz & Ellison, 2009) Few
of these factors have been discussed in the below report:
- Impact on the environment: it is important that before a new project is implemented,
the environmental impact of such project is evaluated. In the given case the project is
expected to have increased carbon emissions which are to harm the environment. Besides
from social obligation, the company might have to face penalties for harming the
environment. Hence before a final call impact on the environment should be evaluated
(Dayananda, Irons, Harrison, Herbohn, & Rowland, 2008).
- Strategic factors: few capital budgeting decisions involve execution of projects which
are not related to the direct goals of the company. The management should not lose sight
of the main objects of the company while taking such decision (Holtzman, 2013).
- Employee Morale: the health of the employees plays a very important in growth of
business. Before taking up a new project the management should evaluate the effect of
such project on employees. If they think that employees can take up and execute and take
up the new project willingly, then only the new project should be accepted. (Menifield,
2014)
- Future demand for the new product: the management should evaluate the market for
the new product before launching a new product. A proper market research should be
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conducted so that the management can evaluate the life of the demand for new product. If
the demand is not expected to last for a long term period then executing a new project
will be in vain. (Noreen, 2015)
Therefore, before a new project is executed, it is important that the management studies all
the aspects properly. (Shapiro, 2007)Effect of all major factors should be consideration
before taking the final capital budgeting decision.
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3. Recommendation and justification
Capital budgeting decision is based on a lot of detailed investigation. (Peterson & Fabozzi,
2012) There are various rules and regulations which are required to be followed in order to
evaluate the feasibility of the project properly. For example, the expense which been already
incurred by the company on market research and project development have not taken into
consideration while taking the decision. This is so because these expenses have already been
incurred and the decision o f acceptance or rejection of project will not affect the expense.
These expenses are sunk cost, and are not considered in evaluating the capital budgeting
projects. (Siciliano, 2015)
Taking all the above data into consideration we can see that the project is to create value for
the company. It is expected to generate profits up to $5.8 million. The pay- back period of the
project is lesser than the required pay-back period by the managers. Hence, we would
recommend the management to accept the project of production of Q-powerboats.
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