Financial Management



Financial Management

Question 1: Elec & Eltek International Company Limited

Key stages in the Capital Investment Decision-Making Process

The following are the main stages in the capital investment decision making process (Northcott, 2012)

Project Identification

Screening of investment project

Evaluating and analyzing investment proposal

Selection stage in which investment proposal is approved

Financing stage in which project funding is decided

Implementation, monitoring, reviewing and controlling investments.

Identification of investment opportunities

It is necessary to identify effective investment opportunities which further transform into profits. This requires appraisal of business environment, in-depth research and development as well as legal requirements. Hence, investment proposal should express or support the main objectives of company.

Screening of investment proposals

According to theories, capital market tends to be imperfect and due to this, availability of finance for capital investments is limited in companies. Therefore, companies require selecting a project that has best strategic plan and fit best in current economic sphere. In order words, exploring best capital investment project that would contribute towards company's objectives (Northcott, 2012).



Evaluating and analyzing investment proposal

Investment proposal must be fully analyzed along with the appraisal that will determine which project offer higher benefit and is most attractive in terms of revenue and opportunity cost such as enhancing shareholder wealth. At this stage, investment appraisal plays an important role such as Net present Value and cost exceeding the expected benefits of another capital investment.

Selection stage in which investment proposal is approved

In this stage company decide which project needs to be put forward and which project should be not. Hence, the proposal is passed to higher level of management for consideration and approval and after this, project is implemented.

Financing stage in which project funding is decided

In this stage, management will look for sponsors to finance their project only in case when project requires higher funding. Otherwise, through internal funding project will be financed.

Implementing, monitoring and reviewing investments

Project implementation depends on the size of the project and complexity in the project. This might take several weeks or months. After implementing the project, this requires regular monitoring in order to make sure that the anticipated results has been achieved and what was expected from project in terms of performance is also achieved. Hence, the entire investment decision making process must be reviewed so that further improvement can be made in future (Northcott, 2012).

Net Present Value (NPV) and Internal Rate Of Return (IRR)

Calculation of NPV

Year

0

1

2

3

4

Investment

-3,000,000

Income

1,802,500

2,387,025

3,278,181

1,547,575

Operating costs

842,700

1,048,662

1,358,970

746,719

Depreciation

700,000

700,000

700,000

700,000

Net profit before tax

259,800

638,363

1,219,211

100,856

Tax rate -17%

44,166

108,522

207,266

17,145

Net profit after tax

215,634

529,841

1,011,945

83,710

Add: Depreciation expense

700,000

700,000

700,000

700,000

Cash flow

-3,000,000

915,634

1,229,841

1,711,945

783,710

 

Discount at 10%

1.0000

0.9091

0.8264

0.7513

0.6830

Present values

(3,000,000)

832,395

1,016,398

1,286,209

535,285

Net present value

670,286

 

 

 

 

Working

Calculation of income

Year

1

2

3

4

Inflated selling price ($/unit)

25.75

26.52

27.32

28.14

Demand (units/year)

70,000

90,000

120,000

55,000

Income ($/year)

1,802,500

2,387,025

3,278,181

1,547,575

Calculation of Operating Costs

Year

1

2

3

4

Inflated variable cost ($/unit)

9.27

9.46

9.64

9.84

Demand (units/year)

70,000

90,000

120,000

55,000

Variable costs ($/year)

648,900

850,986

1,157,341

541,057

Inflated fixed costs ($/year)

193,800

197,676

201,630

205,662

Operating costs ($/year)

842,700

1,048,662

1,358,970

746,719

 

 

Alternative calculation of Operating Costs

 

 

Variable cost ($/unit)

9

9

9

9

Demand (units/year)

70,000

90,000

120,000

55,000

Variable costs ($/year)

630,000

810,000

1,080,000

495,000

Fixed costs ($/year)

190,000

190,000

190,000

190,000

Operating costs ($/year)

820,000

1,000,000

1,270,000

685,000

Inflated Operating costs ($/year)

842,700

1,048,662

1,358,970

746,719

IRR- Internal Rate of Return

Calculation of Internal Rate of Return

Year

0

1

2

3

4

Net cash flow

-3,000,000

915,634

1,229,841

1,711,945

783,710

Discount at 20%

1

0.8333

0.6944

0.5787

0.4823

Present values

(3,000,000)

763,028

854,056

990,709

377,947

Net present value

(14,260)

 

 

Internal rate of return =

10 + ((20 - 10) x 670,286)/( 670,286+ 14,260)

 

IRR

19.79%

 

 

 

 

Apply capital investment decision-making process and comment if the proposal is financially acceptable.

Project has positive Net present value of ...