Investment Appraisal Techniques for Aspiradora Limited

This report discusses the feasibility of two alternative options evaluated by Aspiradora Limited, i.e., introducing a new luxury product called Supanova or expanding the existing product Darkstar. It includes the estimation of annual incremental cash flows for the manufacture of Supanova Vacuum Cleaner, comparative evaluation of the two projects using appropriate appraisal techniques, and problems arising using investment appraisal techniques when the projects are mutually exclusive. It also provides recommendations to Aspiradora regarding the course of action they have to implement. The report concludes that Aspiradora should introduce Supanova as the NPV is positive as compared to Darkstar.

REPORT

Contents
INTRODUCTION...........................................................................................................................3
TASK...............................................................................................................................................3
(A) Estimation of Annual Incremental Cash Flows for The Manufacture of Supanova Vacuum
Cleaner....................................................................................................................................3
(B) Comparative Evaluation of the Two Projects Using Appropriate Appraisal Techniques:5
C) Problems arising using investment appraisal techniques when the projects are mutually
exclusive and discussion on assertion that expansion will generate value to shareholders:. .8
(D) Recommendation to Aspiradora regarding the course of action they have to implement:9
CONCLUSION..............................................................................................................................10
REFERENCES..............................................................................................................................11

INTRODUCTION
Investment appraisal techniques are financial instruments used in the organisation in order to
evaluate the feasibility of the desired project or not. There are numerous investment proposal
techniques such as Net present value method, profitability index, internal rate of return method,
average rate of return and so on (Spencer and et.al., 2019, July). The best method to evaluate the
desirability of the project is NPV method as it considers time value of money and is suitable
when we have to select one proposal amongst the two. In this report there are two alternative
options evaluating by the Aspiradora limited that is whether to introduce a new luxury product in
order to increase the sales in high end market that is bag less and cordless vacuum cleaner called
as Supanova or to go for expansion using the existing product that is Dark star by spending
certain amount of capital investment in market development as suggested by the marketing
managers of Aspiradora. At the end of this report certain recommendation is also provided to the
organisation with respect to selection and reason for the same. It is also recommended that
existing product that is Dark Star must be continue and lower amount of investment to be made
in new product so that its benefits cab be analysed.
TASK
(A) Estimation of Annual Incremental Cash Flows for The Manufacture of Supanova Vacuum
Cleaner.
The following statement has been prepared on the basis on information available. In
preparation of the statement the following assumption has been taken place:
 The Selling price of Supanova has been constant throughout the period of 5 years
 Capital allowance received from the government has been considered as inflow since it is
a rebate on actuation of plant and machinery and must be settled against it.
 The working capital invested over the period of 5 years has been fully recovered at the
end of 5th year fully and all the accounts receivable and payable are settled accordingly.
 There is negative cash balance in the form of inflow in year 1 because cost of plant and
machinery has been considered as cash outflow at the beginning.
 Tax payable on capital gain will be settled at the end of fifth year assuming that it is paid
at the end of project life.

 In calculating the incremental cash flows discounting has not been carried out as question
asked about annual cash flows from the product.
 The overheads are not distributed assuring they are not relevant for decision making as
they already incurred in the existing product.
 The remaining 50% of the amount invested in market research is still unpaid over the
project life.
Statement Showing Annual Incremental Cash Flow for Manufacture of Supanova
Particular 1 2 3 4 5
Cash Inflow:-
Expected Units Sold 100,000 104,000 108,160 112,486 106,862
Selling Price per unit 300 300 300 300 300
Revenue 30,000,000 31,200,000 32,448,000 33,745,920 32,058,624
Sale of Old Machine - 225,000 - - -
Capital Allowance on Machine 1,800,000 1,476,000 1,210,320 992,462 813,819
Recovery of Working Capital - - - - 25,512,407
Salvage value of Machine - - - - 1,500,000
Total Cash Inflow (A) 31,800,000 32,901,000 33,658,320 34,738,382 59,884,850
Cash Outflow:-
Plant and Machine 10,000,000 - - - -
Market Research 45,000 - - - -
Material Cost 10,800,000 11,232,000 11,681,280 12,148,531 11,541,105
Labour Cost 6,000,000 6,240,000 6,489,600 6,749,184 6,411,725
Depreciation on Plant 1,700,000 1,700,000 1,700,000 1,700,000 1,700,000
Tax Payable on Capital Gain - - - - 28,500
( 225000 - 75000 ) * 19%
Rent Paid ( 25% of 160000) 40,000 40,000 40,000 40,000 40,000
Working Capital Requirement 4,800,000 4,992,000 5,191,680 5,399,347 5,129,380

Total Cash Outflow (B) 33,385,000 24,204,000 25,102,560 26,037,062 24,850,709
Annual Incremental Cash Inflow (A-B) (1,585,000) 8,697,000 8,555,760 8,701,320 35,034,141
On the basis of above annul cash flows the conclusion that introduction of Supanova is
beneficial for the organisation as incremental cash flows are positive over the period of 5 Years
and they are consistently increasing also. Further in order to increase the market share the
organisation cab consider the above project instead of investing in the existing product.
(B) Comparative Evaluation of the Two Projects Using Appropriate Appraisal Techniques:
There are various investment appraisal techniques which can be used by the business concern
at the time of evaluating the desirability of the project. Some of them are as under: -
 Net Present Value Method: - It is the best method for deciding which project is to be
selected so that company will be benefited (Morales Henao, 2018). This method is best
because it considers the time value of money. All the cash inflows are discounted using
the cost of capital. The present value of cash inflows is reduced from the cash outflows
and the resultant will be net present value. The decision will be based on NPV that if it
positive then project will be selected otherwise not.
 Profitability Index: - The method is similar to NPV method but the only difference is
that in this method present value of cash inflows are divided by cash outflows. If
profitability index is greater than one, then project will be selected as it represents that
cash inflow are more as compare to outflows. This method measures the effectiveness
and efficiency of project or investment.
 Average Rate of Return Method: - This is the traditional method under which return on
the investment is divided by the cost incurred is such project. Further the return is
considered on average basis. This method is not appropriate because this method is
outdated as it does not consider time value of money. This method indicates the average
annual cash flow generated by the organisation over the life of the investment.
 Internal Rate of Return Method: - In this method IRR is calculated which shows that
present value of cash inflows is equal to cash outflows (Michaud, 2020) . Higher IRR

denotes that project is financially feasible as it justifies that inflows are more as compare
to cash outflows. IRR is the discount rate that make the net present value nil as to make
cash outflows and inflows equals at the desired rate.
 Payback Period: - This method simply indicates that how much time is required by the
project to recover the investment made in it at the beginning of the year. Those project
will be selected whole payback is lower as it showcases that the organisation will recover
its cost at the rapid rate and enjoys the benefit afterword’s.
When we carried out the comparative analysis of the projects under consideration that is
whether to introduced Supanova or to continue with Darkstar model then above techniques needs
to implemented. As NPV is best among all the method therefore feasibility is calculated as
under: -
 If Supanova is developed, then the expected cash inflows can be for the 5 years: -
(A) Supernova Net Present Value: -
Particular 1 2 3 4 5
Cash Inflow:-
Expected Units Sold
100,0
00
104,0
00
108,1
60
112,4
86
106,8
62
Selling Price per unit
3
00
3
00
3
00
3
00
3
00
Revenue
30,000,0
00
31,200,0
00
32,448,0
00
33,745,9
20
32,058,6
24
Sale of Old Machine -
225,0
00 - - -
Capital Allowance on Machine
1,800,00
0
1,476,0
00
1,210,3
20
992,4
62
813,8
19
Recovery of Working Capital - - - -
25,512,4
07
Salvage value of Machine - - - -
1,500,0
00

Total Cash Inflow (A)
31,800,0
00
32,901,0
00
33,658,3
20
34,738,3
82
59,884,8
50
Cash Outflow:-
Plant and Machine
10,000,0
00 - - - -
Market Research
45,0
00 - - - -
Material Cost
10,800,0
00
11,232,0
00
11,681,2
80
12,148,5
31
11,541,1
05
Labor Cost
6,000,00
0
6,240,0
00
6,489,6
00
6,749,1
84
6,411,7
25
Depreciation on Plant
1,700,00
0
1,700,0
00
1,700,0
00
1,700,0
00
1,700,0
00
Tax Payable on Capital Gain - - - -
28,5
00
( 225000 - 75000 ) * 19%
Rent Paid( 25% of 160000)
40,0
00
40,0
00
40,0
00
40,0
00
40,0
00
Working Capital Requirement
4,800,00
0
4,992,0
00
5,191,6
80
5,399,3
47
5,129,3
80
Total Cash Outflow (B) 33,385,000 24,204,000 25,102,560 26,037,062 24,850,709
Annual Incremental Cash Inflow (A-B) (1,585,000) 8,697,000 8,555,760 8,701,320 35,034,141
Discounting @ 13% 0.885 0.783 0.693 0.613 0.543
Present Value of Cash Inflow

(1,402,725) 6,809,751 5,929,142 5,333,909 19,023,538
Net Present Value will be: - 35,693,615
 If the organisation does modification in the existing product that is Darkstar then Net
Present Value would be: -
(B) Dark star Net Present Value: -
Particular 1 2 3 4 5
Cash Inflow:-
Expected Units Sold
20
0,000
20
8,000
216
,320
224
,973
213
,724
Selling Price per unit 126 126 126 126 126
Revenue
25,20
0,000
26,208
,000
27,256
,320
28,346
,573
26,929
,244
Total Cash Inflow (A)
25,20
0,000
26,208
,000
27,256
,320
28,346
,573
26,929
,244
Cash Outflow:-
Market Development
Expenditure 15,000,000 - - - -
Additional Finance 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000
Material and labor cost 20,800,000 21,632,000 22,497,280 23,397,171 22,227,313
Total Cash Outflow (B) 37,800,000 23,632,000 24,497,280 25,397,171 24,227,313
Annual Incremental Cash Inflow

(A-B) (12,600,000) 2,576,000 2,759,040 2,949,402 2,701,931
Discounting @ 13% 0.885 0.783 0.693 0.613 0.543
Present Value of Cash Inflow (11,151,000) 2,017,008 1,912,015 1,807,983 1,467,149
Net Present Value will be: - (3,946,845)
On the basis of the above calculation, it is clear that Aspiradora limited must go with
introduction of Supanova as the NPV is positive as compare to Darkstar.
From the above analysis and facts and figures the conclusion cab be framed that the marketing
manager is correct in suggestion that the expansion project would create greater value to the
shareholder because the organisation is getting much more return from the above project.
C) Problems arising using investment appraisal techniques when the projects are mutually
exclusive and discussion on assertion that expansion will generate value to shareholders:
It refers to the projects in which an organization has to choose single projects out of other
options. It is generally related with the capital budgeting process in which an organization is
required to take long term investing decisions. While selecting the best option in case of
mutually exclusive projects, there are mainly two categories in the investment appraisal
techniques: traditional and modern or discounting models. From modern methods of capital
budgeting in which time value of money is taken into account for detecting the viable project, the
best method is Net present value method (Erkkilä, 2020). It is regarded as best for mutually
exclusive projects because it considers the time value of money and helps the management to
take various decisions. It is computed by taking the difference of net cash inflows and net cash
outflows. If NPV is greater than zero, the project will be selected whereas NPV less than zero
will be rejected. It uses cash flow for computation rather than net earnings. However, NPV deals
with certain issues in its calculation. It works on predictions for cost of capital, setting very high
or low cost of capital creates loss of good investments. It uses discounting factors to evaluate net

present value which makes this tool complex. In case of expansion, the economies of scale can
be achieved and organization will offer more incentives and dividend to its employees. The use
of expansion strategies helps to capture good market shares and increases the earning per share
of the enterprise.
(D) Recommendation to Aspiradora regarding the course of action they have to implement:
It is recommended to the organisation that instead of discontinuing their existing product
they must continue it lower scale of production so that they can get the benefit of economies of
scale. Further since both the products are vacuum cleaner therefore their manufacturing facilities
cab be mixed up together so that cost of the entity has been reduced. It is given in the question
that Supanova is more expensive as the organisation needs to install new machinery for the same.
Another alternate is available that entity can overtakes similar venture so that synergy benefit
they can get. Further if they discontinue their existing products then they lose their existing
customer as Darkstar is their hit product. They can use customised and advantage technology in
order to upgrade the same that will reduce the burden on expenses over them. Further the major
factor that the organisation is ignoring is that these are the projected results of Supanova. Their
might be the possibility that go beyond or against the expectation and as a result of which the
entity will nowhere as they discontinue the current line. When the organisation are dealing with
mutually exclusive project not doubt the cost will reduce to dismantle one project however it also
includes risk on the organisation that if the new product on which the business concern is relying
fails than it is difficult for them to survive in the competition.

CONCLUSION
From the above projects the conclusion can be drawn that decision making with respect to
selection of products requires inverse research considering the structure of the entity and further
estimated cost and expenditure the organisation incurs or earn in implementing that desired
project or product. Further when the organisation is evaluating about selecting mutually
exclusive projects then decision should be taken on implemented appraisal techniques such as
Net present value, profitability index, internal rate of return and so on. In this report Aspiradora
limited wants to analyse regarding the feasibility of Supanove their new bag less and cordless
vacuum cleaner as compare to their existing product which is Darkstar. Since the sale of Darkstar
is decreasing therefore the company is planning to implement the new product. However, this
product is mutually exclusive therefore decision will take in the above mentioned report on the
basis of using appraisal technique. At the end of this report certain recommendation is also
provided to the organisation with respect to selection and reason for the same. It is also
recommended that existing product that is Dark Star must be continue and lower amount of
investment to be made in new product so that its benefits cab be analysed.

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