Financial Management: Reasons for Proposal Reconsideration

This report analyzes a financial management case study involving Airway Technologies, which is considering investing in a new device. The report evaluates the proposal despite the positive Net Present Value (NPV) and Internal Rate of Return (IRR) calculations, highlighting the associated risks. It discusses the limitations of NPV and IRR, such as the failure to account for inflation and the time value of money, as well as the potential for conflicting results and the omission of risk premium. The report emphasizes the importance of re-evaluating the proposal by considering inflationary effects and the probability factor to minimize project risk. Furthermore, it also discusses the potential advantages, such as becoming a market leader if the system is adopted. The report concludes by recommending that Airway Technologies consider these factors to make an informed decision regarding the investment in the proposed system A.

Running head: FINANCIAL MANAGEMENT
Financial Management
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Table of Contents
Reasons for consideration of proposal despite the computation of tremendous Net Present Value
(NPV) and Internal Rate of Return (IRR):......................................................................................2
References:......................................................................................................................................4

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Reasons for consideration of proposal despite the computation of tremendous Net Present
Value (NPV) and Internal Rate of Return (IRR):
According to the provided case study, Ed Draycutt is the engineering manager of Airway
Technologies. This organisation is involved in making computer systems for control installations
of air traffic at the airports. The person has proposed a new device and the success is reliant on
two distinct events. This device would cost $20 million; however, this has been a considerable
investment for the organisation. However, the organisation could incur serious losses and it
might result in liquidation, if the system fails to work.
However, there are certain risks associated with the proposal despite the positive values
of NPV and IRR. The major problem associated with this is that there has been no depiction of
4% probability in the presentation that the organisation might lose $20 million. Hence, this
necessitates the organisation to re-consider the business proposal with other techniques for
evaluating the actual feasibility of investment (Baum & Crosby, 2014).
Although both NPV and IRR are considered the best measures of investment appraisal,
however, these methods have certain limitations. The NPV method does not take into account the
negative effects of inflation, which might reduce the profitability and productivity of an
investment appraisal (Dyson & Berry, 2014). On the other hand, the internal rate of return fails
to take into account the time value of money. In addition, this method also fails to consider the
negative impact of inflation, which might negatively influence the scope of the investment
appraisal (Götze, Northcott & Schuster, 2015). Moreover, the project size could not be gauged
with the help of the method of net present value. Another disadvantage associated with the

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method of internal rate of return is that it could lead to conflicting results for mutually exclusive
projects.
Moreover, Ed Draycutt has not added the method of including risk premium to the rate of
discount. This is intended mainly to adjust the risk, which could increase the cost artificially or
incorrectly (Götze, Northcott & Schuster, 2015). Moreover, when the incorporation of risk
premium is made into the discount rate, it results in compounding impact from additional risk
premium. As a result, such compounding effects could lead to a lower NPV. Hence, Airway
Technologies might incur severe losses, if it adopts the proposed system.
However, it has been observed that if the system A is not adopted, the Airway could lose
the entire amount invested in the development of new service. Furthermore, if the industrial
standard requires the system A, it would help the organisation to become the market leader, as o
other organisation has the similar device available. Hence, in order to evaluate the feasibility of
the proposed investment, Airway Technologies is required to consider the inflationary effects
and the probability factor by reducing the estimates of cash flows by 4%. Such technique would
help in minimising the overall project risk and hence, appropriate decision could be undertaken
regarding the commencement of the proposed investment on system A.

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References:
Baum, A. E., & Crosby, N. (2014). Property investment appraisal. John Wiley & Sons.
Dyson, R. G., & Berry, R. H. (2014). Capital investment appraisal. Developments in Operational
Research: Frontiers of Operational Research and Applied Systems Analysis, 59.
Götze, U., Northcott, D. & Schuster, P. (2015). Capital Budgeting and Investment Decisions.
In Investment Appraisal (pp. 3-26). Springer Berlin Heidelberg.
Götze, U., Northcott, D., & Schuster, P. (2015). Investment appraisal: methods and models.
Springer.