Financial Analysis

Financial Analysis

Introduction

The main task of the investment analysis is to calculate the efficiency of the investment project and assess its riskiness. In other words, the best choice is made on two parameters: the effectiveness of risk and efficiency of the investment project.

Investment analysis considers only the incremental cash flows, i.e. the result of changes in the flow of income and expenses after tax, due to the implementation of the investment project. This do not take into account any costs or revenues volumes, which are almost same before and after the implementation of the investment project.

Discussion

Part 1)

In order to make purchase decision between two available options, it is necessary to evaluate the investment decision through the investment techniques that has been stated by different authors.

The investment decision of Modern Electronics whether to investment in Machine A or Machine B, the investment techniques which will be use are Net present value method and internal rate of return. These methods are given more priority than other methods that are available. The following is the data of two machines (Lawrence, 2008).

Data

Initial Investment A

100,000

Initial Investment B

100,000

Tenure

5 years

Required rate of return

10%

Profits after taxation

Years

Machine A

Machine B

Cash Inflows (RO)

Cash Inflows (RO)

1

30,000

10,000

2

40,000

30,000

3

50,000

40,000

4

30,000

60,000

5

20,000

40,000

Machine A

Discount Factor

10%

Cash Flow

Timing Of Cash Receipt

Year

Cash-In

Cash-Out

Net Cash Flow

Discount Factor

Discounted Cash flow

Beginning Year 1

0

1

100,000

-100000

1

-100000

End Year 1

1

30,000

0

30,000

0.909

27270

End Year 2

2

40,000

0

40,000

0.826

33040

End Year 3

3

50,000

0

50,000

0.751

37550

End Year 4

4

30,000

0

30,000

0.683

20490

End Year 5

5

20,000

0

20,000

0.621

12420

Totals

$170,000

$100,000

70000

Net Present Value (NPV)

£30770

IRR

 21.971%

Machine B

Discount Factor

10%

Cash Flow

Timing Of Cash Receipt

Year

Cash-In

Cash-Out

Net Cash Flow

Discount Factor

Discounted Cash flow

Beginning Year 1

0

1

100,000

-100000

1

-100000

End Year 1

1

10,000

0

10,000

0.909

9090

End Year 2

2

30,000

0

30,000

0.826

24780

End Year 3

3

40,000

0

40,000

0.751

30040

End Year 4

4

60,000

0

60,000

0.683

40980

End Year 5

5

40,000

0

40,000

0.621

24840

Totals

$180,000

$100,000

80000

Net Present Value (NPV)

£29730

IRR

19.00%

Analysis and Literature

Financial management focuses for evaluating investment decisions on those models that take into account the value of money over time, correlating sources of financing and the weighted average cost of capital as basic data for calculations.

Looking at the above NPV and IRR calculation, NPV of Machine A is £30,770 while NPV of Machine B is £29, 730. According the literature of NPV, NPV determines whether a project earns more or less than desired rate of return (also called hurdle rate). Hence, Machine A is generating more in future rather than Machine B. According to the IRR method which determines the maximum cost of capital employed, and which investment project is profitable. Machine A IRR is 21.97% while Machine B IRR is 19%. Hence, this is favouring Machine A (Paul, 2009).

The above decision has been taken after studying the literature and previous studies of the investment analysis techniques.

According to the literature, when there are two project and decision has to been made on one investment i.e. mutually exclusive project or alternate projects investment then NPV has been given more priority and concern than any other capital budgeting technique. This is due to increase in the value of the share holder wealth and shareholder looks the ...