Investment Appraisal Methods: Payback Period and Net Present Value

This report discusses the payback period and net present value methods for investment appraisal. It includes the calculation of the payback period and net present value for Project A and Project B. The analysis shows that Project B has a lower payback period and higher net present value, making it a better investment option. The report also explores the financial and non-financial factors that affect business decision-making.

INDIVIDUAL ESSAY

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY..................................................................................................................................3
Task..................................................................................................................................................3
Calculation of Pay Back Period of Project A and Project B........................................................3
Calculation of Net Present Value of Project A and Project B.....................................................4
Analysis of calculation/ Final Decision.......................................................................................5
Financial Factor...........................................................................................................................6
Non-financial Factor....................................................................................................................6
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................1

INTRODUCTION
Investment appraisal methods is a technique with the help of which the company can easily
analyse more than one proposal at a time and select one of the suitable and profitable projects for
the company. This report will discuss the payback period and net present value method along
with their calculation for making the decision regarding which project is better out of project A
and B.
MAIN BODY
Task
Calculation of Pay Back Period of Project A and Project B
Payback period is a capital budgeting technique which state that the company have to
select the project which reflect lower PB period. PB period is a period in which the company is
able to recover all its initial investment from the project (Yang, 2018).
Formula (in case of uneven cash flow) = A + B/ C
Here, A = last period no. with negative cumulative cash flow
B = Absolute value i.e., value with last negative sign
C = Total cash inflow in the next period just after period A
Project A (Belt)
Time (in years) Cash Flows (€) Cumulative Cash flows (€)
0 (170000) (170000)
1 45000 -125000
2 45000 -80000
3 35000 -45000
4 70000 25000
5 82000 107000
3 year + 45000/ 70000
3 years + .64 months = 3.7 years
Project B (trainers)
Time (in years) Cash Flows (€) Cumulative Cash flows (€)

0 (190000) (190000)
1 50000 -140000
2 45000 -95000
3 70000 -25000
4 90000 65000
5 90000 155000
3 years + 25000/ 90000
3 years + .27 months = 3.2 years
Calculation of Net Present Value of Project A and Project B
Net present value is another technique of investment appraisal which help the company in
making the decision by converting the future cash inflows into present value. It is basically the
difference between the present value of cash inflow and initial investment (Gaspars-Wieloch,
2019).
Formula of NPV = Present value of cash flows – Initial investment
Project A (Belt)
Time (in years) Cash flows (€)
(A)
Discounting factor
@14%
(B)
Present value of cash
flow after
discounting (€)
(A) * (B)
0 (170000) 1 (170000)
1 45000 0.8772 39474
2 45000 0.7695 34627.5
3 35000 0.6750 23625
4 70000 0.5921 41447
5 82000 0.5194 42590.8
Total NPV 11764.3
Project B (trainers)
Time (in years) Cash flows (€) Discounting factor Present value of cash

(A)
@14%
(B)
flow after
discounting (€)
(A) * (B)
0 (190000) 1 (190000)
1 50000 0.8772 43860
2 45000 0.7695 34627.5
3 70000 0.6750 47250
4 90000 0.5921 53289
5 90000 0.5194 46746
Total NPV 35772.5
Analysis of calculation/ Final Decision
Payback period of project A = 3.7 years
Payback period of project B = 3.2 years
NPV of project A = €11764.3
NPV of project B = €35772.5
Initial Investment of project A = €170000
Initial Investment of project B = €190000
From the above data, it is clearly indicating that the payback period and the net present
value of project B is better than the project A. It is because the PB period of project B is lower
than the project A and it meets the selection criteria of PB. And the NPV of the project B is
higher than the project A and meet the selection criteria of NPV method. Basically, NPV is
consider as optimal and best method for selection of project in the decision-making process
because it considers the time value of money and payback period because it is simple to calculate
and understand. It helps the company in reducing the risk because it simply focused on how
quickly company receive its money from an investment. So, form the above analyses it is
recommended to the DDK plc. that they should invest their fund in project B even though it
requires more initial investment. Because it is more suitable and profitable for the company as
compared to the project A. It also helps the company in managing their liquidity position.

Financial Factor
 Interest Rate: Interest rate is directly linked with the cost of the borrowings. If the
interest rate is lower than the borrowing cost become cheaper and people spend more
money. But if the interest rate increases then it makes borrowing cost expensive and
people will shift their decision from spending to saving (Brunnermeier and Koby, 2018).
 Inflation Rate: Inflation rate indicate the continuous increase in the prices of the
products and services and it affects the consumer spending patterns badly. It also affects
the cost of material the company pays and lead to stock shortage if the replacement cost
of inventory is more than selling price of stock (O’Neill, Ralph and Smith, 2017).
 Income tax: Tax policy highly affects the business decision of the company. It is because
if the income tax increases it increases the cost of the company and in order to recover
this amount, they increase their prices of the products (Gong and et.al., 2018).
Non-financial Factor
 Political Factor: Political factor involve the government pressure on the business
regarding following all the rules and regulation set by them. If the company do not follow
this then the government interfere in the business decision (Lampaki and Papadakis,
2018).
 Environmental Factor: Producing goods and services which is environmentally friendly
is must for the company in order to build strong brand image in the eye of community.
The company have to make decision which favours the less use of natural resources and
focus sustainability development (Popovič and et.al., 2018).
 Ethical Factor: Ethical factor affect the business decision in large extent because of
social pressure regarding the ethical code of company. Ethical behaviour at workplace is
must which state that company have to treat all of its employees equally (Latan, Jabbour
and de Sousa Jabbour, 2017).
CONCLUSION
The report concludes that how the investment appraisal techniques such as payback
period and net present value help the DDK plc. is selecting the project B for the purpose of
investment. The report also concludes the financial factors and non-financial factors which

affects the decision making of the company. The report also concludes the meaning of PB and
NPV along with their calculation.

REFERENCES
Books and journals
Yang, M. H., 2018. Payback period investigation of the organic Rankine cycle with mixed
working fluids to recover waste heat from the exhaust gas of a large marine diesel
engine. Energy Conversion and Management. 162. pp.189-202.
Gaspars-Wieloch, H., 2019. Project net present value estimation under uncertainty. Central
European Journal of Operations Research. 27(1). pp.179-197.
Brunnermeier, M. K. and Koby, Y., 2018. The reversal interest rate (No. w25406). National
Bureau of Economic Research.
O’Neill, R., Ralph, J. and Smith, P. A., 2017. What Is Inflation?. In Inflation (pp. 21-43).
Palgrave Macmillan, Cham.
Gong, M. and et.al., 2018. Inside out: The interrelationships of sustainable performance metrics
and its effect on business decision making: Theory and practice. Resources, Conservation and
Recycling. 128. pp.155-166.
Lampaki, A. and Papadakis, V., 2018. The impact of organisational politics and trust in the top
management team on strategic decision implementation success: A middle-manager's
perspective. European Management Journal. 36(5). pp.627-637.
Popovič, A. and et.al., 2018. The impact of big data analytics on firms’ high value business
performance. Information Systems Frontiers. 20(2). pp.209-222.
Latan, H., Jabbour, C. J. C. and de Sousa Jabbour, A. B. L., 2017. Ethical awareness, ethical
judgment, and whistleblowing: A moderated mediation analysis. In Partial Least Squares Path
Modeling (pp. 311-337). Springer, Cham.
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