Word Count 1,516
Table of Contents
Introduction
The original machine
Report to the Manager
Recommendation
Bibliography
Investment Appraisal of James Company
Introduction
The James Company is a congregation of the church related-related institutions and offers the wide range of the funds and development for the materials and services in cultivating the resources for accomplishing its goal (James Company Corporate Website, 2008).
In this regard, the company is considering initially bottle production operations which can costs ₤ 300,000 and has the 5 year life whereas at the end, there is no residual value yet expected to generate ₤35, 000 every year for 5 years. In computing for the highest possible cost of capital for the investment or the rate of return for the firm in the investment in satisfying the firm’s sources for its financing, it is only important to use the net present value. Using the formula for the Net present value, it can be followed that:
Year
Cash Flow
Present Value
T = 0
-₤300,000
-₤300,000
T =1
₤35,000
₤35,000
T = 2
₤35,000
₤35,000
T = 3
₤35,000
₤35,000
T = 4
₤35,000
₤35,000
T = 5
₤35,000
₤35,000
Net Present Value
-₤125,000
Thus, the investment for this project can generate -₤125,000 which shows a loss for the company and it is not advisable to accept the investment or the new machine and there will be no case for investment.
The average annual profit for is used in profit fluctuates every year. Thus, the Kips has average annual profit of 25, 000 / 5 expected years = 5,000.
Year
Kips
Cash Flow
0
-50,000
-50,000
1
25,000
25,000
2
20,000
20,000
3
15,000
15,000
4
10,000
10,000
5
5,000
5,000
Total
25,000
For Queens, it has the profit every year of 40,000 / 5 = 8,000.
Year
Queens
Cash Flow
0
-50,000
-50,000
1
5,000
5,000
2
15,000
15,000
3
25,000
25,000
4
25,000
25,000
5
20,000
20,000
Total
40,000
40,000
Thus, the Queens has the highest expected average annual profit every year as compared to the Kip’s.
On the other hand, the company is also considering the other cheaper machine that includes the Kips and Queens though different specification; it has the same price of ₤ 50, 000. In order to decide for the best decision, the company needs to make the necessary analysis. The average annual profit which can be computed as annual cash flow – annual depreciation costs (For Kips, the Average Annual Profit can be seen below:
Year
Kips
Cash Flow
0
-50,000
-50,000
1
25,000
25,000
2
20,000
20,000
3
15,000
15,000
4
10,000
10,000
5
5,000
5,000
Total
25,000
The return on the original investment (ROI) is the average profit for the annual profit of the project that had been express in percentage and its fixed management (Mott, 2008, p.211). Thus, the return on the original investment for Kips is 25,000 / 5 = 5,000. If we assume that the project is negligible, the working capital then the expected original investment can be computed as 5,000 / 10000 *100 = 50%.
On the other hand, Queens’ original capital employed can be computed as:
Year
Queens
Cash Flow
0
-50,000
-50,000
1
5,000
5,000
2
15,000
15,000
3
25,000
25,000
4
25,000
25,000
5
20,000
20,000
Total
40,000
40,000
Therefore, the return on the original investment for Queens is 40,000 / 5 = 8,000. If we assume that the project is negligible, the working capital then the expected original investment can be computed as 8,000 / 10,000 *100 = 80%.
In this manner, the company has the options of accepting the Queens for having higher investment return in percentage.
The rate of average capital investment (RAI) is also similar in the ROI whereas the divisor is only similar in the outstanding investment and the working capital. This can be computed and assumed that there is straight line depreciation for the machines of 2,000. For Kips, the rate of average capital investment (RAI) is 5,000 / 15,000 *100 = 33.33%.
Year
Kips
Cash Flow
0
-50,000
-50,000
1
25000 -2000
23,000
2
20000-2000
18,000
3
15000-2000
13,000
4
10000-2000
8,000
5
5000-2000
3,000
Total
15,000
The Queens on the other hand has the rate of average capital investment of 8,000 / 30,000 * 100 = 26.26%.
Year
Queens
Cash Flow
0
-50,000
-50,000
1
5000-2000
3,000
2
15000-2000
13,000
3
25000-2000
23,000
4
25000-2000
23,000
5
20000-2000
18,000
Total
30,000
The payback period is the number of years that the company can recover in its initial investment. Thus, computing the value of payback period of Kip’s is taking the first three years profit as 20,000 + 25,000 = 45,000 that lacks only 5,000 (divides the 3rd year profit of 15,000) to make it 50,000. Then, 5,000 / 15,000 = 0.33 or almost 4 months, then, the payback period for the company is 2 years and 4 months. On the other hand, the Queens needs to take the 4 years which are 5,000, 15,000, 25,000, which costs 45,000. It lacks 5,000 that need to divide in the 4th year. The 5,000 / 25,000 = 2 months is the resulting payback period of 3 years and 2 months of Queens.
The original machine
It has NPV of with 10% rate of return. The computed internal rate of return is -15.64% which are same for the 20% of expected rate of return. The formula is finding the value that can satisfy the equation:
Year
Cash Flow
Present Value
T = 0
-₤300,000/ (1+.10)0
-₤300,000
T =1
₤35,000/(1+.10)1
₤31,818.18
T = 2
₤35,000/(1+.10)2
₤28,925.62
T = 3
₤35,000/(1+.10)3
₤26,296.02
T = 4
₤35,000/(1+.10)4
₤23,905.47
T = 5
₤35,000/(1+.10)5
₤21,732.25
Net Present Value
-167,322.46
The other one is NPV with 20% rate of return.
Year
Cash Flow
Present Value
T = 0
-₤300,000/ (1+.20)0
-₤300,000
T =1
₤35,000/(1+.20)1
₤29,166.67
T = 2
₤35,000/(1+.20)2
₤24,305.56
T = 3
₤35,000/(1+.20)3
₤20,254.63
T = 4
₤35,000/(1+.20)4
₤16,878.86
T = 5
₤35,000/(1+.20)5
₤14,065.72
Net Present Value
-₤195,328.56
For Kips’ and 10% of rate of return, the internal rate of return is 20.27% and it was also the same as the 20% for the expected rate of return.
Year
Cash Flow
Present Value
0
-50000 / (1+.10)0
-50000
1
25000 / (1+.10)1
22,727.27
2
20000 / (1+.10)2
16,528.93
3
15000 / (1+.10)3
11,269.72
4
10000 / (1+.10)4
6,830.13
5
5000 / (1+.10)5
3,104.60
Net Present Value
₤10,460.65
For the Kip’s and its 20% of the rate of return:
Year
Cash Flow
Present Value
0
-50000 / (1+.20)0
-50000
1
25000 / (1+.20)1
20,833.33
2
20000 / (1+.20)2
13,888.89
3
15000 / (1+.20)3
8,680.56
4
10000 / (1+.20)4
4,822.53
5
5000 / (1+.20)5
2,009.39
Net Present Value
₤234
For the Queens, 10% with the internal rate of return of 19.353% with the same as the 20% rate of return.
Year
Cash Flow
Cash Flow
0
-50,000
-50,000
1
5,000 / (1.1)1
5,000
2
15,000 / (1.1)2
12,396.69
3
25,000 / (1.1)3
18,782.87
4
25,000 /(1.1)4
17,075.33
5
20,000 / (1.1)5
12,418.42
Net Present Value
₤15,673
If it was 20%,
Year
Cash Flow
Cash Flow
0
-50,000
-50,000
1
5,000 / (1.20)1
5,000
2
15,000 / (1.20)2
10,416.67
3
25,000 / (1.20)3
14,467.59
4
25,000 /(1.20)4
12,056.33
5
20,000 / (1.20)5
62,500
Net Present Value
₤54,441
Thus it shows that the Queens with 20% of the expected rate of return is the best investment that company can use.
Report to the Manager
There are many ways in the specific project and its evaluation that had been used in this project proposal. The first one is the Return on Investment or the very popular metric due to its versatility and simplicity. This can also be modified in order to suit into the situation though depends on the costs or returns. Nevertheless, this can be manipulated easily and results can be express in many ways which can mislead the readers. The payback period is also one of the methods that the proposal had due to the fact that it is simple to use and can tell the duration for earning back the money that can be spend in the project. But, this can ignore the benefits which can occur in the payback period. The NPV is advisable to use in using the time value money in appraising the long-term projects that can use in budgeting and through economics. There are disadvantages of using the NPV in the calculations as the sensitivity for the discount rates and really the summation of the multiple that are discounted cash flow. This method also excludes the real options which can exist in the investment. The average profit is the years that can be taken in consideration which summed up. This implies that the estimate in the future can be done on the performance of the past and can accrue in the future and depends on its performance though the past data cannot be the exact and it is risky to use (Singal, n.d., p. 64).
Recommendation
The company therefore needs to purchase the Queens machine as it generates much income and return to the project yet it s cheaper as compared to the other machines. The project also has high interest rate of return.
Bibliography
Mott, G 2008, Accounting for Non-Accountants: A Manual for Managers and Students, Kogan Page, United Kingdom.
About James Company 2008, James Company, viewed 14 October, 2008, http://jamescompany.com/about.asp.
Singal, n.d., Corporate Accounting, VK Publications, United Kingdom.
Credit:ivythesis.typepad.com
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