Business Decision Making Essay: NPV, Payback Period, ABC Plc Case

This essay analyzes business decision-making processes, focusing on financial and non-financial factors that influence investment decisions. The case study of ABC Plc, a computer software company, is used to illustrate the application of Net Present Value (NPV) and payback period techniques for evaluating two potential projects: a motor software project and a hardware project. The essay calculates and compares the NPV and payback periods for both projects, demonstrating how these financial metrics can inform investment choices. Furthermore, it explores the importance of financial factors such as interest rates and economic growth, along with non-financial factors including legislation and industry stability, in the decision-making process. The conclusion emphasizes that project B is the most suitable for ABC Plc due to its higher NPV and shorter payback period, providing insights into effective business strategy.

Business Decision Making

Contents
INTRODUCTION...........................................................................................................................1
MAIN BODY..................................................................................................................................1
Net present value.........................................................................................................................1
Pay back period............................................................................................................................2
Financial and non financial factors..............................................................................................4
CONCLUSION................................................................................................................................4
REFERENCES................................................................................................................................5

INTRODUCTION
Business decision making is a procedure of managing business activities by taking
appropriate decisions for the operations of a business. This procedure involves selection of most
suitable alternative which can help business in achieving its goals (Burgass, Arlidge and
Addison, 2018). The main aim of this report is to build an understanding about the various
financial and non financial factors which impacts decision making. For this purpose, the case of
ABC Plc is selected in this essay which is a computer software company. In order to expand its
operations, this company is planning to investing in a new project. In this essay, two projects are
compared using techniques of NPV and Payback period along with description of other financial
and non financial factors.
MAIN BODY
Net present value
ABC Plc. is considering investing in a new project for this analysis using NPV is done. Net
present value is a financial metric which helps an organisation to ascertain present value of a
project by computing discounted factor value. This technique is a tool of ascertaining the future
profitability of a project and helps in evaluating whether the specific project is viable for the
company or not.
This technique has its own benefits and limitations which must be considered before
selecting it as a base of decision making. The major benefit of this technique is that it considers
time value of money by computing discounted factor value. Also, NPV is designed to factor the
risks which can be faced in a project. Limitations of this technique includes ignorance of sunk
cost and optimistic projections (Chen, Treviño and Humphrey, 2019).
For the present case, NPV for both the projects that are motor software and hardware
project is analysed below:
Formula: NPV = Cash flow / (1+i) t - initial investment
PROJECT A: Motor Software Project
Year Net cash flow PV factor @ 12% Discounted cash flow
1 8000 0.892857143 7142.857143
2 12000 0.797193878 9566.326531
3 16000 0.711780248 11388.48397
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4 20000 0.635518078 12710.36157
5 30000 0.567426856 17022.80567
Total discounted cash flow 57830.83488
Less: initial investment 40000
Net Present value 17830.83488
PROJECT B: Hardware Project
Year Net cash flow PV factor @ 12% Discounted cash flow
1 10,000 0.892857143 8928.571429
2 20,000 0.797193878 15943.87755
3 25,000 0.711780248 17794.5062
4 30,000 0.635518078 19065.54235
5 40,000 0.567426856 22697.07423
Total discounted cash flow 84429.57176
Less: initial investment 60000
Net Present value 24429.57176
From the above numerical analysis, it can be clearly seen that when the initial investment
of project A is £40000 then the net present value of that project is £17831. On the other hand,
initial investment of project B is £60000 and NPV is £24430. Net cash flows for every year of
project B are greater than project A; from which it can be said that project B is a more
appropriate choice for ABC Plc.
Pay back period
Payback period is a tool by which an organisation can ascertain the time period in which
they can coup up their invested capital in a project. This measure does not account for time value
of money. This financial metric has its own benefits and demerits which promote and restrict the
use of this technique in certain cases. The main benefit of this technique is that it is easier to
calculate and helps to evaluate projects quickly. The demerit of this technique includes that it
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does not consider time value of money and neglects negative cash flows (Van Knippenberg and
et.al., 2015).
This technique is applied to calculate the payback time in which organisation can recoup
its initial investments from both the projects. Payback period for both the projects is calculated
below:
PROJECT A: Motor Software Project
Year Net cash flow Cumulative Cash Flow
1 8000 8000
2 12000 20000
3 16000 36000
4 20000 56000
5 30000 86000
The initial investment of this project is £40000. In year 3, £36000 out of £40000 will be
recovered; remaining £4000 will be recovered in next 2.4 months.
Payback period = 2 + (4000 / 20000 * 12)
= 3 + 2.4
= 3 years and 2.4 months
PROJECT B: Hardware Project
Year Net cash flow Cumulative Cash Flow
1 10,000 10000
2 20,000 30000
3 25,000 55000
4 30,000 85000
5 40,000 125000
Initial investment of hardware project is £60000. In year 3, £55000 from £60000 will be
recovered. Remaining £5000 will be recovered in next 2 months.
= 3 + (5000 / 30000 * 12)
= 3 + 2
= 3 years and 2 months.
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From the above evaluation, it is clear that project B is slightly more effective when it
comes to payback period. Project B can help ABC Plc to procure their initially invested funds in
a period of just 3 years and 2 months.
Financial and non financial factors
Decision making is a continuous process and there are various factors which can aid in the
process of decision making. Some of the financial factors are interest rates and economic growth.
If ABC Plc is planning to invest in a new project, then it is important for them to procure funds.
This company will consider the funds which has low interest rate on the loaned amount. The
factor of economic growth also influences decision making as the company will select the
particular project which will assist them in gaining economic growth (Levy, 2015).
Apart from above financial factors, there are few non financial factors as well which can
impact decision making of an organisation. These factors include legislations applied to the
organisation and industry stability. ABC Plc. will select the project which will not imply any
legal obligations to them so that they function smoothly. Also, if the industry in which this
company operate is stable then only company will plan to invest in new projects so that risk of
uncertainty can be minimised (Chisholm, 2017).
CONCLUSION
From the above essay, it has been concluded that decision making procedure is based on
several elements. From the numerical analysis, it has been found that project B is more
appropriate for ABC Plc as it will imply gaining high net present value and the initial investment
will be re coup in 3 years and 2 months.
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REFERENCES
Books and Journals
Burgass, M. J., Arlidge, W. N. and Addison, P. F., 2018. Overstating the value of the IUCN Red
List for business decision‐making. Conservation Letters. 11(3). p.e12456.
Chen, A., Treviño, L. K. and Humphrey, S. E., 2019. Ethical champions, emotions, framing, and
team ethical decision making. Journal of Applied Psychology.
Chisholm, R., 2017. Interorganizational decision making. Routledge.
Levy, H., 2015. Stochastic dominance: Investment decision making under uncertainty. Springer.
Van Knippenberg, D., and et.al., 2015. Information, attention, and decision making.
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