Calculation of NPV and Payback Period

This document provides a case study on investment appraisal techniques, specifically the calculation of NPV and Payback Period. It discusses the financial and non-financial factors that influence investment decisions. The case study focuses on ABC Plc and their decision to invest in a new business project.

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Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
TASK ..............................................................................................................................................3
Calculation of NPV and Payback Period....................................................................................3
Payback Period.............................................................................................................................4
Net Present Value (NPV).............................................................................................................5
Financial factors...........................................................................................................................5
Non- financial factors..................................................................................................................6
CONCLUSION................................................................................................................................6
REFERENCES ...............................................................................................................................7

INTRODUCTION
Decision making process in an organization is very essential because it influence entire
process of the business. Investment related decisions are very important, so management will
take with the help of analysing their proposals (Fan and Xia, 2018). Investment appraisal
technique is the tool which help managers to identify which project is beneficial as well as
attractive for the business. Strategic managers of ABC plc wants to invest in new business and
they find two suitable project. Managers will make final decisions after evaluation results of
payback period or NPV. In addition, identify financial or non financial factors which affect those
project.
MAIN BODY
TASK
Calculation of NPV and Payback Period
Year Project A PV @ 12% DCF Project B PV @ 12% DCF
0 -£ 40,000 1 -£ 40,000 -£ 60000 1 -£ 60000
1 £ 8,000 0.893 £ 7,143 £ 10,000 0.893 £ 8,929
2 £ 12,000 0.797 £ 9,566 £ 20,000 0.797 £ 15,944
3 £ 16,000 0.712 £ 11,388 £ 25,000 0.712 £ 17,795
4 £ 20,000 0.636 £ 12,710 £ 30,000 0.636 £ 19,066
5 £ 30,000 0.567 £ 17,023 £ 40,000 0.567 £ 22,697
NPV £ 17,831 NPV £ 24,430
According to above calculation, it has been observed that NPV of project A is £ 17,831
and project B will provide £ 24,430. Strategic manager of ABC Plc select the high NPV value
which means they select project B to invest for new business.
Year Project A (£) Cumulative cash flow (£) Project B (£) Cumulative cash flow (£)
0 40000 0 60000 0

1 8000 8000 10000 10000
2 12000 20000 20000 30000
3 16000 36000 25000 55000
4 20000 56000 30000 85000
5 30000 86000 40000 125000
Formula:
Payback Period = Year before full recovery + Unrecoverable amount / Cash flow of the year
Project A
= 3 + 4000 / 20000
= 3 + 0.2
= 3.2 years
Project B
= 3 + 5000 / 30000
= 3 + 0.16
= 3.16 years
From the above based calculation, both projects have almost similar recovery time but
project B take less time in comparison to project A.
Payback Period
It is refer to the time period which indicate that company can recover their amount within
that period. Low payback period is beneficial for organizations because they can recover their
initial cost very fast and further generate more profit (Gorshkov And et.al., 2018). As per above
calculation of payback period, both projects recovery year almost very close such as payback
period of project A is 3.2 years and project B is 3.16 years. Project B is more favourable in
comparison to project A, so ABC Plc should invest in this new project and it helps in recover
their initial cost in comparison to others. In addition, managers should also know about its
advantages or disadvantages before making decisions in respect of business. These are as follow:
Benefits:

It is one of the simple method of investment appraisal technique which is used to evaluate
attractiveness as well as profitability of project. Low payback period is beneficial for the
organization top invest.
Limitation:
It does not consider the time value of money as well as ignore cash inflow after payback
period. Payback period unable to recognise that investment generate value for the company or
not.
Net Present Value (NPV)
NPV is one of the essential techniques which is used by the organization to evaluate their
project value as well as identify that it is beneficial in the future or not. Positive NPV collected
and consider as favourable for the organizations. As per above calculation of both investment
proposal, it is observe that project A provide £ 17,831 and project B is £ 24,430. Higher the NPV
selected for the better returns such as Project B (Khajehvajari, 2019). Managers of ABC Plc
should invest on second business because it helps in recovering fast and generate more value in
comparison to other. Before making final decisions, they need to evaluate advantages or
disadvantages of NPC and these are as follow:
Advantages:
NPV is one of accurate method to evaluate project returns and it is based on discounting
factor which helps in generating present value of cash flows. In addition, it consider the time of
money which provide opportunity cost.
Disadvantages:
Cash inflow based on discounted rate which can vary the results and NPC compare with
other projects but if initial investment amount is same.
Financial factors
At the time of making any decisions in the organization, managers should evaluate the
financial aspect of business to make profitable decision which further helps in maximising
productivity as well as profitability (Wati, Pakpahan and Novirasari, 2018). Financial factors
includes economic growth, interest rate etc. as everybody know that, low interest rate is
beneficial for the business or high interest rate reduce the overall savings. When managers make
decision to expand their business, they have to borrow money and make sure that, they get on
lower rate which maximise profit margin. On the other side, economic growth of UK is in

favourable of investors but still they need to keep monitor the movement and make business
decision accordingly.
Non- financial factors
In the organization, when managers make decisions they need to evaluate non financial
factors as well which directly or indirectly influence the decision of entity. There are various
tools which helps in analysing non financial factors such as SWOT and PESTEL analysis. By
using these tools, business able to identify future opportunities, current strengths & weakness or
threats that is barrier for the company (Zativita and Chumaidiyah, 2019). In addition, PESTLE is
a external environmental analysis which influence overall demand and productivity of business.
These analysis will helps in improving decision making process and also find the potential risk in
the future.
CONCLUSION
From the above discussion it has been evaluated that business decision making is critical
task, so it required various aspects to analyse such as financial or non financial factors. In
addition, with the helps of investment appraisal techniques such as NPV or payback period, ABC
plc select Project B to invest in new business.

REFERENCES
Books & Journals
Fan, Y. and Xia, X., 2018. Energy-efficiency building retrofit planning for green building
compliance. Building and Environment. 136. pp.312-321.
Gorshkov, A.S. And et.al., 2018. Payback period of investments in energy saving. Magazine of
Civil Engineering, (2).
Khajehvajari, M., 2019. Optimization of a Data-Driven Customer Relationship Management
System for Better Decsion-Making.
Wati, M., Pakpahan, H. S. and Novirasari, N., 2018. September. Comparative Analysis of Multi-
Criteria Decision Making for Student Degree Completion Time based on Entropy
Weighted. In 2018 International Conference on Applied Information Technology and
Innovation (ICAITI) (pp. 56-61). IEEE.
Zativita, F. I. and Chumaidiyah, E., 2019. May. Feasibility analysis of Rumah Tempe Zanada
establishment in Bandung using net present value, internal rate of return, and payback
period. In IOP Conference Series: Materials Science and Engineering (Vol. 505, No. 1,
p. 012007). IOP Publishing.