Business Decision Making: NPV and Payback Period Analysis

This essay analyzes the business decision making of XYZ plc. using investment appraisal techniques of NPV and payback period. It also discusses the financial and non-financial factors that impact the decision making process.

Project

Contents
Introduction......................................................................................................................................1
Essay body.......................................................................................................................................1
Computation of the payback period.............................................................................................1
Computation of NPV...................................................................................................................2
Analysis.......................................................................................................................................3
Conclusion.......................................................................................................................................5
REFERENCES................................................................................................................................6

Introduction
Business decision making is a concept involving setting the goal for an organisation and
then developing strategies which can help in acquiring that goal (Keršulienė and Turskis, 2014).
The present essay is based on the business decision making of XYZ plc.; two projects of this
company are analysed with the help of investment appraisal techniques of NPV and pay back
period Along with it, this essay will also include financial and non financial factors that impacts
the decision making process of a company.
Essay body
Computation of the payback period
The investment appraisal technique of payback period helps in calculating the time period
which an investment will take to recover its initial outlay (Gorshkov, 2018). For two projects of
XYZ Plc., the payback period is calculated below:
According to the information given for project A, the initial investment required for this
project is £100,000. From the above table, it can be seen that this amount is recovered after year
3.
So, Payback period = 3 + (5000 / 55000 * 12)
= 3 + 0.090 * 12
= 3 + 1.09
= 3 years and 1 month
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For the second project which is a Laundrette project, the initial investment is £120,000. This
amount will be recovered after 3rd year by the difference of £8000.
So, the Payback period = 3 + (8000 / 64000 * 12)
= 3 + 0.125 * 12
= 3 + 1.5
= 3 years and 1.5 months
Computation of NPV
The investment appraisal technique of NPV or net present value is considered as the most
effective criteria for decision making (Wetekamp, 2011). This technique calculates the present
value of the future investment which helps in deciding whether the investment is viable or not.
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Analysis
Payback period
The technique of pay back period allows to conduct quick assessment of invetsments
from which an investiogator can compute that which invetsment will result into quick recoverty
of its initial invetsed fund. This technique has its own benefits and limitations due to which its
suitability for ecah kind of project variates. The pay back period for two investments of XYZ Plc
are caclulated. From this technique, it has been seen project A is slighly more effective than
project B as the project A will require 3 years and 1 month to recover its initial amount and
project B will require 3 years and 1.5 months to recover its initial amount.
The benefits of pay back period includes quick and esay assessment of invetsments which
does not requires high skills. In addition, this technique helps in analysing the liquidity position
of the company. These benefits are shadowed by the limitations of this technique. The technique
of pay back period does not account for time value of money due to which, this technique is
considered as less reliable. In addition to this, ignorance to cost of capital and capital wastage is
also a limitation of this technique (Carmichael, 2011).
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Net present value
The technique of NPV is a metric that helps in calculating the present value of a future
investment by considerng time value factor and contingency expenses. This tcehnique is used for
the two desired investments of XYZ Plc. From the caluclation of NPV, it has been seen that
project B is more effective than project A as the NPV of proejct B is 65186 that is quite higher
than project A’s NPV which is 59308.
Similar to any other technique, NPV also has few benefits and limitations that makes it
appropriate for certan times of project. The benefits of NPV includes consideration of time value
of money and cash flows, assumption of reinvetsment and factoring risks. Apart from this, NPV
also has a limitation that states NPV neglects the sunk cost of an invetsment and is complex to be
undertaken when compared to Pay back period (Galperin, Fishman and Gibiansky, 2012).
The above analsis of NPV and pay back period shows that the payback period is a much less
reiable technique than NPV as it ignores time value of money and both the investments of XYZ
Plc are of 5 years and this much of time cannot be ignored. So, it can be said that as NPV of
Project B is higher, the XYZ Plc should invest their monetary resources in project B of
Laundrette Project.
Financial factors
It is certain that in order to identify the suitable investment, investment appraisal
techniques must be used. But besides these techniques, there are some other financial factors that
can impact the decision of investment. These factors are:
Inflation – Due to inflation, the value of currency degrades which impacts the future
value of an investment. This variation in future value of investment will impact the decision
making of the investment.
Return on Investment – This factor is an influential factor for investment decision
making. Return of an investment allows organisations to earn profit and variation in this return
directly impacts the decision of the company like XYZ Plc.
Non-financial factors
Besides all the financial factors, there are few non financial factors as well that impacts
the investment decision of an organisation. These factors are:
Technological – Every industry has its own pace to upgrade technology that impacts the
invetsment decision of the companies in that market. If this pace increases rapidly the it an
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impact the decision making of XYZ Plc. The rapid upgradation of technology will lead this
company to invest in more enhnaced projects rather than the projects which will become obsolete
in near future.
Legal – This factor is a macro non financial factor which impacts the decision making of
organisations. If the laws authorising XYZ Plc changes which restricts them to use certain kind
of software then his company has to adapt project B and eliminate project A of software.
Conclusion
The above essay helps in gaining conclusion that every investment appraisal technique has
its own benefits and limitations which make them suitable for a certain kind of investments. It
has been concluded that XYZ Plc. must invest in project B by considering all potential financial
and non financial factors.
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REFERENCES
Books and Journals
Carmichael, D.G., 2011. An alternative approach to capital investment appraisal. The
Engineering Economist. 56(2). pp.123-139.
Galperin, Y., Fishman, V. and Gibiansky, L., Experian Information Solutions LLC,
2012. Method for optimizing net present value of a cross-selling marketing campaign.
U.S. Patent 8,285,577.
Gorshkov, A.S., 2018. Payback period of investments in energy saving. Инженерно-
строительный журнал: специализированный научный журнал, (2 (78)).
Keršulienė, V. and Turskis, Z., 2014. An integrated multi-criteria group decision making
process: selection of the chief accountant. Procedia-Social and Behavioral Sciences. 110.
pp.897-904.
Wetekamp, W., 2011, September. Net Present Value (NPV) as a tool supporting effective project
management. In Proceedings of the 6th IEEE International Conference on Intelligent
Data Acquisition and Advanced Computing Systems (Vol. 2, pp. 898-900). IEEE.
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