Investment Project Analysis and NPV

This assignment focuses on evaluating the profitability of an investment project. Students are tasked with calculating the Net Present Value (NPV) under different scenarios: a fixed selling price, a fluctuating selling price, and a fluctuating labor cost. The NPV calculations consider various cash flows throughout the three-year lifespan of the project. Tables provided in the assignment document outline the initial investment, annual net cash flow, recoverable working capital, and discount factors for different years.

ACCOUNTING
AND FINANCIAL
MANAGEMENT
1

Table of Contents
INTRODUCTION ...............................................................................................................................4
PART 1 ................................................................................................................................................4
PART 2..................................................................................................................................................6
(1) All possible scenarios with graph...............................................................................................6
Calculation of Expected NPV..........................................................................................................8
Calculation of standard deviation of NPV.......................................................................................9
Recommendation to Cashion International......................................................................................9
PART 3..................................................................................................................................................9
Calculation of payback period and internal rate of return...............................................................9
Advice to Cashion International whether to run project, sell or conduct an marketing campaign
.......................................................................................................................................................10
CONCLUSION...................................................................................................................................11
REFERENCES...................................................................................................................................12
APPENDIX........................................................................................................................................13
Index of Tables
Table 1: Cumulative cash inflows and future values of cash inflow....................................................4
Table 2: Annual cash flow at 1.8 selling price and fluctuate labour cost.............................................5
Table 3: Annual cash flow at £2.16 S.P. And fluctuate labour cost.....................................................6
Table 4: Annual cash flow at £1.53 S.P. And fluctuate labour cost.....................................................6
Table 5: Calculation of standard deviation...........................................................................................8
Table 6: Calculation of PP and IRR .....................................................................................................8
Table 7: Calculation of NPV at £1.8 selling price and fluctuate labour cost......................................12
Table 8: Calculation of NPV at £2.16 selling price and fluctuate labour cost....................................12
Table 9: Calculation of NPV at £1.53 selling price and fluctuate labour cost....................................12
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INTRODUCTION
Every business organization has to make investment in some capital projects such as new
machinery and acquisition of new building. Effective investment decisions lead to business success
and vice versa. Thus, it becomes necessary for the organizations to evaluate the project return so
that they can take better decisions. Present project report will address the significance of investment
appraisal techniques such as payback period, internal rate of return and net present value to take
strategic investment decisions.
PART 1
Albanian government is auctioning the rights to mine copper in the east of the country.
Mines International (MI) is a considering to determine the amount will be require to pay as lump
sum for acquiring five-year license.
Net cash inflow: It can be computed through determining the difference between cash inflow and
outflow (Thijssen, 2010).
Year 1 2 3 4 5
Opening cash balance 2 2 2 2
Sales
Cash sales 6.4 7.2 7.2 5.6
Credit sales 1.6 1.8 1.8
Resale value of the engineering
equipment 2
Total cash inflows 0 8.4 10.8 11 11.4
Expenses
Cash material and comsumable
purchase 0.36 0.24 0.3 0.3 0.24
Credit material and consumables
purchase 0.24 0.16 0.2 0.2
Wages and salaries 0.3 0.7 0.7 0.7 0.7
Overheads 0.15 0.25 0.35 0.35 0.25
Albainian government payments 0.65 0.65 0.65 0.65 0.65
Survey costs 0.15
Specialised machinery hire costs 0.12
Specialised engineering equipment
costs 5.5
7.11 2.08 2.28 2.2 2.04
Total cash outflows -7.11 6.32 8.52 8.8 9.36
3

Less: Budgeted cash reserve 2 2 2 2 2
Deficit -9.11 4.32 6.52 6.8 7.36
Assumptions:
 It has been assumed that MI will make 80% sales in cash and 20% on credit for 4 months.
 Cash material and consumable purchase has been assumed at 60% and remaining 40% on
credit for 4 months.
 Only the project related overheads has been considered for computing NCF.
 Albanian government will make a one-off refund of administration charges at the end of
fifth year which is not considered because it does not drive any cash inflow during the
project life.
 Special equipment cost worth £11m has been considered and out of this half will be paid at
the time of initial investment and remaining will be paid in next year.
In order to determine maximum amount of auction bid, MI should compute total cash
inflows and future value of CI from the project. It is because MI should not invest more than future
values of cash inflows than it will bear loss while excess of initial investment over the potential
future values will results in profit (Investment appraisal, 2008).
Cumulative cash inflows and Future values of cash inflow
It can be determined through consistently adding of cash inflows over the project duration. It
helps to compute payback period which reflects the time period require to re-earn the initial cash
outlay. While, the drawback of this method is it ignore time value of money and does not consider
post pay back profitability (Al-Ajmi, Al-Saleh and Hussain, 2011). On the other hand, net present
value can be determined by considering future values of all the cash inflows. The advantage of this
method is it consider time value of the money through using discounting factor. The disadvantage of
this method is determining an appropriate discount rate is very difficult task (Carr, Kolehmainen
and Mitchell, 2010). Moreover, using an standard rate for overall project duration can not be
considered realistic. For the present project, 10% discount rate is using.
Table 1: Cumulative cash inflows and future values of cash inflow
Year Cash flow PV of £1 @ 10% Future value
1 -9.11 0.909 -8.28099
2 4.32 0.826 3.57
3 6.52 0.751 4.89652
4 6.8 0.683 4.6444
4

5 7.36 0.621 4.57056
Total FV 15.89 9.39881
Thus, it can be said that MI's total cash inflow is £15.89 while potential future values is
£9.39881. Moreover, initially, MI will invest £5.5m for special engineering equipment thus,
maximum bid price for auction will be £9.39-£5.5 = £3.89.
To
CEO of Mines International
Date: 20th April, 2016
Respected Madam/Sir,
After evaluating projected cash inflows and their future values, it can be said that MI
should invest maximum amount of £3.89 to obtain the license. Further, NPV is the more superior
method because it consider time value of money and calculate potential project return.
From: CEO
PART 2
As per the scenario, it has been stated that Cashion International is considering to invest
initial investment of £78000 in a new project. Its projected life time will be 3 years. Out of this,
£65000 will be invest in machinery while remainder £13000 will be for working capital which will
be recover at the end of the life time.
(1) All possible scenarios with graph
Table 2: Annual cash flow at 1.8 selling price and fluctuate labour cost
Particulars £1.8 S.P. and 0.8
labour cost
£1.8 S.P. And £1 L.C. £1.18 S.P. and £1.18
L.C.
Annual sales of 90000
units
162000 162000 162000
Annual costs
Material 36000 36000 36000
Labour 72000 90000 106200
Others 10000 10000 10000
Total cash outflow 118000 136000 152200
Annual net cash flow 44000 26000 9800
5

Table 3: Annual cash flow at £2.16 S.P. And fluctuate labour cost
Particulars £2.16 S.P. and
0.8 labour cost
£2.16 S.P. And £1
L.C.
£2.16 S.P. and £1.18
L.C.
Annual sales of 90000 units 194400 194400 194400
Annual costs
Material 36000 36000 36000
Labour 72000 90000 106200
Others 10000 10000 10000
Total cash outflow 118000 136000 152200
Annual net cash flow 76400 58400 42200
6
£1.8 S.P. and 0.8 labour cost
£1.8 S.P. And £1 L.C.
£1.18 S.P. and £1.18 L.C.
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
50000
44000
26000
9800
£2.16 S.P. and 0.8 labour cost
£2.16 S.P. And £1 L.C.
£2.16 S.P. and £1.18 L.C.
0
10000
20000
30000
40000
50000
60000
70000
80000
90000
76400
58400
42200

Table 4: Annual cash flow at £1.53 S.P. And fluctuate labour cost
Particulars £1.53 S.P. and 0.8
labour cost
£1.53 S.P. And £1
L.C.
£1.53 S.P. and £1.18
L.C.
Annual sales of 90000
units
1377000 137700 137700
Annual costs
Material 36000 36000 36000
Labour 720000 900000 106200
Others 10000 10000 10000
Total cash outflow 1180000 136000 152200
Annual net cash flow 197000 17000 -14500
As per the graph, it can be seen that higher the selling price contribute to high turnover and
profitability as well otherwise vice-versa. While, high labour costs will results in increase total cash
7
£1.53 S.P. and 0.8 labour cost
£1.53 S.P. And £1 L.C.
£1.53 S.P. and £1.18 L.C.
-20000
-15000
-10000
-5000
0
5000
10000
15000
20000
25000
19700
1700 -14500

outflow and decline profitability otherwise vice-versa.
Calculation of Expected NPV
This method indicates the potential return by computing the difference between project costs
and sum of future values of cash inflows (Baker and Powell, 2009).
Attached in Appendix 1, 2 and 3
According to this, Cashion International company will generate high NPV worth £121693.4
at £2.16 selling price and £0.8 labour cost.
Calculation of standard deviation of NPV
Table 5: Calculation of standard deviation
S.No. Expected NPV
1 41147
2 -3601
3 -43874.2
4 121693.4
5 76945.4
6 36672.2
7 -19262.8
8 -64010.8
9 -104284
10 71465.58
Recommendation to Cashion International
This project will generate highest NPV of £121693.4 at the standard deviation of £71465.58
while other alternative projects has NPV and standard deviation of £31000 and £80000 respectively.
Thus, it interpreted that company should not invest funds in this alternative proposal because of
less NPV and high standard deviation.
PART 3
Calculation of payback period and internal rate of return
Pay back period: It indicates the time period in which project will recover its initial
investment of £78000 (Hunjra and et.al., 2012).
Internal rate of return: It is the discounting rate at which Cashion International will neither
earn any profit nor loss (Götze, Northcott and Schuster, 2015).
8

As per the scenario, PP and IRR at £2.16 selling price and £1.18 labour cost are calculated
hereunder:
Table 6: Calculation of PP and IRR
Year Cash flow
Cumulative cash
flow
0 -78000 -78000
1 42200 -35800
2 42200 6400
3 42200 48600
Recoverable W.C. 13000 61600
IRR 32.72%
Payback period = 1 year + (£35800/£42200)
= 1 + 0.85 year
= 1.85 year
Interpretation
Yes, Cashion International should accept this proposal because its PP is 1.85 year which
reflects that firm will recover its initial investment in shorter period. Moreover, IRR of 32.72% is
far greater than cost of capital of 10% which is good.
Advice to Cashion International whether to run project, sell or conduct an marketing campaign
(a) Sale the project
1st year cash inflow £42200
Cash inflow from Gumgrass Ltd £90000
Initial cost £78000
Net Cash flow £54200
b) Run marketing campaign
Year Cash flow (In £) Marketing
campaign cost (In
£)
Net cash flow (In £)
0 -78000 -78000
1 42200 42200
2 42200 30000 12200
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3 42200 42200
4 42200 42200
Net Cash flow 60800
C) Run project
Year Cash flow (In £)
0 -78000
1 42200
2 42200
3 42200
Net Cash flow 48600
Recommendation
Thus, it can be advised that Cashino International should not sale the project and conduct a
market campaign at a cost of £30000 to extend project life span for 1 year. So that, firm will
generate high cash flow worth £60800 compare to other alternatives.
CONCLUSION
Report concluded that MI should bid for £3.89 to obtain license for mine. While, second part
concluded that Cashion international should not invest funds in alternative proposal whose NPV is
£31000 and standard deviation is £80000. At the end, report concluded that Cashion should
organize a marketing campaign at the cost of £30000. It will help to generate high cash flow of
£60800.
10

REFERENCES
Books and Journals
Al-Ajmi, J., Al-Saleh, N. and Hussain, H.A., 2011. Investment appraisal practices: A comparative
study of conventional and Islamic financial institutions. Advances in Accounting. 27(1). pp.
111-124.
Baker, H.K. and Powell, G., 2009. Understanding financial management: A practical guide. John
Wiley & Sons.
Carr, C., Kolehmainen, K. and Mitchell, F., 2010. Strategic investment decision making practices: A
contextual approach. Management Accounting Research. 21(3). pp. 167-184.
Götze, U., Northcott, D. and Schuster, P., 2015. Discounted Cash Flow Methods. In Investment
Appraisal. Springer Berlin Heidelberg. pp. 47-83.
Hunjra, A.I. and et.al., 2012. Investment appraisal techniques and constraints on capital investment.
Actual Problems of Economics. 2(4).
Thijssen, J.J., 2010. Irreversible investment and discounting: an arbitrage pricing approach. Annals
of Finance. 6(3). pp. 295-315.
Online
Investment appraisal, 2008. [Pdf]. Available through:
<http://www.businessstudiesalevel.co.uk/investment%20appraisal.pdf>. [Accessed on 20th
April, 2016].
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APPENDIX
Table 7: Calculation of NPV at £1.8 selling price and fluctuate labour cost
Particulars £1.8
S.P.
and
0.8
labour
cost
£1.8
S.P.
And
£1 L.C.
£1.18 S.P.
and £1.18
L.C.
DF @
10%
DCF DCF DCF
Initial
investment
-78000 -78000 -78000 1
-78000
-78000 -78000
Annual net
cash flow
44000 26000 9800 2.486 at
the end of
3rd year
109384 64636 24362.8
Recoverable
W.C.
13000 13000 13000 0.751 9763 9763 9763
NPV 41147 -3601 -43874.2
Table 8: Calculation of NPV at £2.16 selling price and fluctuate labour cost
Particulars £2.16
S.P. and
0.8
labour
cost
£2.16
S.P.
And
£1 L.C.
£2.16 S.P.
and £1.18
L.C.
DF @
10%
DCF DCF DCF
Initial
investment
-78000 -78000 -78000 1
-78000
-78000 -78000
Annual net
cash flow
76400 58400 42200 2.486 at
the end of
3rd year
189930.4 145182.4 104909.2
Recoverabl
e W.C.
13000 13000 13000 0.751 9763 9763 9763
NPV 121693.4 76945.4 36672.2
Table 9: Calculation of NPV at £1.53 selling price and fluctuate labour cost
Particulars £1.53
S.P. and
0.8
labour
cost
£1.53
S.P.
And
£1 L.C.
£1.53 S.P.
and £1.18
L.C.
DF @
10%
DCF DCF DCF
Initial
investment
-78000 -78000 -78000 1
-78000
-78000 -78000
12

Annual net
cash flow
19700 1700 -14500 2.486 at
the end of
3rd year
48974.2 4226.2 -36047
Recoverabl
e W.C.
13000 13000 13000 0.751 9763 9763 9763
NPV -19262.8 -64010.8 -104284
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