FINANCIAL PLANNING

Financial Management & Control

Financial Management & Control

Part A - Pearson Ltd.

Capital budgeting is an important pillar of financial management and controlling at an organization. There are four appraisal methods selected to evaluate the feasibility of capital investment decision.

Advice on Investment Decision

Analysis of the four appraisal methods suggests that the company would be able to cover its invested money in a suitable duration. The project is economically feasible for the company; hence, it should invest money in the purchase of new machine.

Payback Period

Investment analysis through payback period suggests that the company will be able to recover its invested amount of capital within 2.92 years of the investment. The decision seems to be economically feasible for the company, as it will allow quick recovery of money. Therefore, the company should invest in the purchase of new machine.

 Payback Period

 

Number of Years

Cash flow Stream

Cumulative Cash Flow

0

(200,000)

(200,000)

1

65,000 (135,000)

2

65,000 (70,000)

3

65,000 (5,000)

4

65,000 60,000

Payback Period (years)

 

2.92

Table 1: Payback Period Analysis

Discounted Payback Period

Discounted payback period analysis of the available investment options shows that the company may recover its investment within 2.14 years of the investment period. In other words, purchase of new machine will enhance business efficiency and it will allow the company to recover money within the original life of the purchased machine. The decision is viable and Pearson Ltd. should make this investment.

 

 Discounted Payback Period

 

 

Number of Years (n)

Cash Flow (CF)

Present Value Factor PV £1=(1/((1+i)^n))

Discounted Cash Flow (CF * PV £1)

Cumulative Discounted Cash Flow

0

(200,000)

1.0000 (200,000)

(200,000)

1

65,000 0.9091 59,091 (140,909)

2

65,000 0.8264 53,719 (87,190)

3

65,000 0.7513 48,835 (38,355)

4

65,000 0.6830 44,396 6,041

Discounted Payback Period (years)

 

 

 

2.14

Table 2: Discounted Payback Period Analysis

Net Present Value (NPV)

NPV is an appropriate appraisal technique to evaluate the feasibility of an investment option or future project. NPV analysis of the present investment options shows positive NPV results for the company. It shows that if the company utilizes machine at its full life and resells it at the end of the life i.e. 4th year for an amount of 40,000, it will be able to recover £30,329 by the end of the project.

 

 Net Present Value (NPV)

 

Number of Years (n)

Cash Flow (CF)

Present Value Factor PV $1=(1/((1+i)^n))

Discounted Cash Flow (CF * PV $1)

0

(200,000)

1.0000 (200,000)

1

65,000 0.9091 59,091

2

65,000 0.8264 53,719

3

65,000 0.7513 48,835

4

105,000 0.6830 71,716

NPV

£30,329 £33,362

Table 3: Net Present Value Analysis

Hence, decision is economically feasible for the company, and it should invest money in the purchase of new machine.

Internal Rate of Return (IRR)

Analysis of proposed decision shows that the company will be able to generate 16.50% IRR from this investment, which is 6.50% more than the cost of capital being raised for this investment project. Therefore, company must invest money in the purchase of new machine.

IRR

 

NPV at 16%

£3,425.33

NPV at 17%

(£293.78)

IRR

16.50%

IRR (Calculation)

16.92%

Table 4: Internal Rate of Return Analysis

On the basis of formula calculation, IRR can be calculated as follows:

Based on this formula, IRR is 16.92%, which means the company will be able to recover good ...