ACCOUNTING

Accounting - M. Smith Co Ltd

Accounting - M. Smith Co Ltd

Section 1 - Investment Appraisal

M. Smith Co Ltd is placed with three alternatives of capital project that may help the firm to meet the objective of creating optimum utilization of cash. However, the three projects have different cost of capital, useful life and cash inflows. Hence, NPV and discounted payback period are selected as an appropriate approach to assist the firm in selecting the most suitable capital investment project on justified basis.

Net Present Value (NPV)

Project 1 has an initial cash outlay of £ 300, 000 at a discount rate of 7%. Projections show that the project will produce uneven cash flows for the next four years. NPV analysis shows that the project has potential to produce fruitful results by posting NPV value of £ 28, 720.71. Since NPV is positive at the given cost of capital, project 1 is a potential choice of capital investment for M. Smith Co Ltd (Lam, n.d., p. 2).

Project 1

Years (n)

Cash flows (CF)

Discount Factor (DF)

Discounted Cash flow (DCF)

0

(300,000)

1.00 (300,000)

1

60,000 0.935 56,100

2

65,000 0.872 56,680

3

80,000 0.816 65,280

4

200,000 0.763 152,600

NPV @ 7%

£28,720.71

30,660

 

 

 

 

Table 1: NPV Appraisal of Project 1

Project 2 requires an initial cash investment of £ 300, 000 at the cost of 11%. Cash flow projections recognize uneven expected cash inflows for the next three years. In the light of NPV analysis, project 2 is incapable of meeting firm's investment objective because it has posted negative NPV value of £ 33.13. In other words, project 2 is less capable of recovering the initial cash investment; hence, it cannot meet the optimum cash utilization objective of the firm (Peterson-Drake, n.d., p. 1).

Project 2

Years (n)

Cash flows (CF)

Discount Factor (DF)

Discounted Cash flow (DCF)

0

(300,000)

1.00 (300,000)

1

90,000 0.901 81,090

2

85,000 0.812 69,020

3

205,000 0.731 149,855

 

 

NPV @ 11%

(£33.13)

(35)

 

 

 

 

Table 2: NPV Appraisal of Project 2

Project 3 proposes a long term investment plan with an initial investment of £ 650, 000 at a rate of 14%. Projections show that the project will produce even cash flows of worth £ 115, 000 for the next 15 years. In accord with NPV analysis, project 3 has a potential to meet cash optimization objective of the firm. Project 3 has recorded a positive and relatively higher NPV value of £ 1, 356, 349. Hence, there is a good probability for project 3 to be a future investment choice of the firm (Lam, n.d., p. 2).

Project 3

 

 

NPV=

PMT*[{1-(1+i)^-n}/i]-Cash outlay

 

 

NPV=

115,000*[{1-(1+14%)^-15}/14%]-650,000

 

 

NPV @ 14%=

1,356,349

 

 

Table 3: NPV Appraisal of Project 3

Discounted Payback Period (DPP)

Discounted payback period (DPP) analysis shows that project 1 will generate uneven cash flows for the next 4 years. However, the initial cost investment is expected to be recovered within 2.2 years of initial investment. Hence, project 1 can be selected by the firm to meet its objective (Peterson-Drake, n.d., p. 1).

Project 1

Years (n)

Cash Flows (CF)

Discount Factor (DF)

Discounted Cash Flows (DCFs)

Cumulative Discounted Cash Flows (CDCFs)

0

(300,000)

1

(300,000)

(300,000)

1

60,000 0.935

56,100

(243,900)

2

65,000

...