The project appraisal is a structured approach which starts from estimating the future cash inflows and outflows and ends with determining the financial viability of the project. There are different methods being used in assessing the project’s financial viability such as net present value, internal rate of return, and payback period. Each method has its own peculiarities and therefore, none of these can be said to be superior to the other (Ehrhardt and Brigham, 2008). It depends upon the situation as to which method is to be applied in assessing the project’s financial viability. In this context, this report has been prepared for Needle Manufacturing to analyze three alternatives in regard to the machine replacement decision. There are three different machines being considered to replace the current one.
Net Present Value Method
The net present value method is the most commonly applied method for the purpose of evaluation of the project’s financial viability. Under this method, the net present value is computed by deducting the present value of all cash outflows from the present value of cash inflows of the project. The project having highest positive net present value is considered the most appropriate and hence selected for implementation (Ehrhardt and Brigham, 2008). The net present value method produces analysis of profitability of the project which is primary advantages of this method. It becomes easier to measure the contribution of project to the shareholder’s worth by analyzing the project under net present value method. The biggest disadvantage of net present value method is that it does not fit for analysis when the projects being analyzed are of different sizes. Further, the analysis of net present value also does not provide the rate of return earned by the investors as provided by the internal rate of return method (Ehrhardt and Brigham, 2008). In regards to the Needle Manufacturing, the analysis of the net present value of three different machines is presented in the tables given below:
Alternative-1: Alph Machine |
||||
Year |
Description |
Amount (£) |
Present Value (£) |
|
0 |
Initial Outlay |
(500,000.00) |
1.0000 |
(500,000.00) |
1 |
Cash inflow |
50,000.00 |
0.9091 |
45,454.55 |
2 |
Cash inflow |
100,000.00 |
0.8264 |
82,644.63 |
3 |
Cash inflow |
150,000.00 |
0.7513 |
112,697.22 |
4 |
Cash inflow |
150,000.00 |
0.6830 |
102,452.02 |
5 |
Cash inflow |
150,000.00 |
0.6209 |
93,138.20 |
6 |
Cash inflow |
170,000.00 |
0.5645 |
95,960.57 |
Present Value |
32,347.18 |
Alternative-2: Beat Machine |
||||
Year |
Description |
Amount (£) |
Present Value (£) |
|
0 |
Initial Outlay |
(500,000.00) |
1.0000 |
(500,000.00) |
1 |
Cash inflow |
200,000.00 |
0.9091 |
181,818.18 |
2 |
Cash inflow |
150,000.00 |
0.8264 |
123,966.94 |
3 |
Cash inflow |
150,000.00 |
0.7513 |
112,697.22 |
4 |
Cash inflow |
50,000.00 |
0.6830 |
34,150.67 |
5 |
Cash inflow |
25,000.00 |
0.6209 |
15,523.03 |
6 |
Cash inflow |
25,000.00 |
0.5645 |
14,111.85 |
Present Value |
(17,732.10) |
Alternative-3: Camn Machine |
||||
Year |
Description |
Amount (£) |
Present Value (£) |
|
0 |
Initial Outlay |
(500,000.00) |
1.0000 |
(500,000.00) |
1 |
Cash inflow |
150,000.00 |
0.9091 |
136,363.64 |
2 |
Cash inflow |
150,000.00 |
0.8264 |
123,966.94 |
3 |
Cash inflow |
150,000.00 |
0.7513 |
112,697.22 |
4 |
Cash inflow |
150,000.00 |
0.6830 |
102,452.02 |
5 |
Cash inflow |
100,000.00 |
0.6209 |
62,092.13 |
6 |
Cash inflow |
50,000.00 |
0.5645 |
28,223.70 |
Present Value |
65,795.65 |
The results of the analysis conducted above depicts that the alternative-1 with Alph Machine is yielding a net present value of $32,347.18. The alternative-2 with Beat Machine is yielding net present value of $-17732.10 while the alternative-3 with Camn machine is yielding net present value of $65,795.65. It could be observe that the alternative-3 with Camn machine is yielding the highest net present value. Therefore, based on the net repent value it could be analyzed that the alternative-3 would be first choice in front of the management for replacement of the old machine.
The internal rate of return (IRR) method provides computation of the rate of return that the investor will yield on the amount invested (Gitman, 2007). This method is considered superior than the accounting rate of return because it takes into consideration the time value of money. In the internal rate of return method, the project’s IRR is compared with the company’s required rate of return and the project yielding highest IRR is considered the best for implementation. The internal rate of return method is simple in interpreting the results and understanding the outcome. However, it may be computationally very difficult in the situations of unconventional cash flows. In the cases when the stream of cash flows involves both cash inflows as well as outflows over the entire period of the project, the computation of IRR becomes difficult. Further, the analysis of different size projects by applying IRR method is not considered appropriate (Gitman, 2007). In regard to Needle Manufacturing, the computation of IRR for all three alternatives is given as below:
Alternative-1: Alph Machine |
||
Year |
Description |
Amount (£) |
0 |
Initial Outlay |
(500,000.00) |
1 |
Cash inflow |
50,000.00 |
2 |
Cash inflow |
100,000.00 |
3 |
Cash inflow |
150,000.00 |
4 |
Cash inflow |
150,000.00 |
5 |
Cash inflow |
150,000.00 |
6 |
Cash inflow |
170,000.00 |
IRR |
11.86% |
Alternative-2: Beat Machine |
|||||
Year |
Description |
Amount (£) |
|||
0 |
Initial Outlay |
(500,000.00) |
|||
1 |
Cash inflow |
200,000.00 |
|||
2 |
Cash inflow |
150,000.00 |
|||
3 |
Cash inflow |
150,000.00 |
|||
4 |
Cash inflow |
50,000.00 |
|||
5 |
Cash inflow |
25,000.00 |
|||
6 |
Cash inflow |
25,000.00 |
|||
IRR |
8.23% |
||||
Alternative-3: Camn Machine |
|||||
Year |
Description |
Amount (£) |
|||
0 |
Initial Outlay |
(500,000.00) |
|||
1 |
Cash inflow |
150,000.00 |
|||
2 |
Cash inflow |
150,000.00 |
|||
3 |
Cash inflow |
150,000.00 |
|||
4 |
Cash inflow |
150,000.00 |
|||
5 |
Cash inflow |
100,000.00 |
|||
6 |
Cash inflow |
50,000.00 |
|||
IRR |
14.96% |
||||
Alternative-1: Alph Machine |
|||||
Year |
Description |
Amount (£) |
Present Value |
Cumulative PV |
|
0 |
Initial Outlay |
(500,000.00) |
1.0000 |
(500,000.00) |
|
1 |
Cash inflow |
50,000.00 |
0.9091 |
45,454.55 |
(454,545.45) |
2 |
Cash inflow |
100,000.00 |
0.8264 |
82,644.63 |
(371,900.83) |
3 |
Cash inflow |
150,000.00 |
0.7513 |
112,697.22 |
(259,203.61) |
4 |
Cash inflow |
150,000.00 |
0.6830 |
102,452.02 |
(156,751.59) |
5 |
Cash inflow |
150,000.00 |
0.6209 |
93,138.20 |
(63,613.39) |
6 |
Cash inflow |
170,000.00 |
0.5645 |
95,960.57 |
32,347.18 |
Payback Period (Years) [5+63613.39/95960.57] |
5.66 |
||||
Alternative-2: Beat Machine |
|||||
Year |
Description |
Amount (£) |
Present Value |
Cumulative PV |
|
0 |
Initial Outlay |
(500,000.00) |
1.0000 |
(500,000.00) |
|
1 |
Cash inflow |
200,000.00 |
0.9091 |
181,818.18 |
(318,181.82) |
2 |
Cash inflow |
150,000.00 |
0.8264 |
123,966.94 |
(194,214.88) |
3 |
Cash inflow |
150,000.00 |
0.7513 |
112,697.22 |
(81,517.66) |
4 |
Cash inflow |
50,000.00 |
0.6830 |
34,150.67 |
(47,366.98) |
5 |
Cash inflow |
25,000.00 |
0.6209 |
15,523.03 |
(31,843.95) |
6 |
Cash inflow |
25,000.00 |
0.5645 |
14,111.85 |
(17,732.10) |
Payback Period (Years) |
6.00 |
Alternative-3: Camn Machine |
|||||
Year |
Description |
Amount (£) |
Present Value |
Cumulative PV |
|
0 |
Initial Outlay |
(500,000.00) |
1.0000 |
(500,000.00) |
|
1 |
Cash inflow |
150,000.00 |
0.9091 |
136,363.64 |
(363,636.36) |
2 |
Cash inflow |
150,000.00 |
0.8264 |
123,966.94 |
(239,669.42) |
3 |
Cash inflow |
150,000.00 |
0.7513 |
112,697.22 |
(126,972.20) |
4 |
Cash inflow |
150,000.00 |
0.6830 |
102,452.02 |
(24,520.18) |
5 |
Cash inflow |
100,000.00 |
0.6209 |
62,092.13 |
37,571.95 |
6 |
Cash inflow |
50,000.00 |
0.5645 |
28,223.70 |
65,795.65 |
Payback Period (Years) [4+24520.18/62092.13] |
4.39 |
The results of the analysis presented above show that the payback period of alternative-1 with Alph machine is 5.66 years. Further, the payback period of alternative-2 with Beat machine has been found to be 6 years. It could be observed that the initial outlay is not even getting recovered fully in 6 years time period in case of alternative-2. The cash outflow of $17,732.10 is remaining at the end of 6th year unrecovered. Further, in the case of alternative-3, the payback period has been found to be 4.39 years. It could be observed that the payback period of alternative-3, is the lowest which implies that this alternative is the best choice for the management.
From the analysis of all three alternatives, it has been observed that the alternative-3 with Camn machine is the best choice available for the management for replacement of the old machine. The alternative-3 has dominated the other two alternatives in the analysis of net present value, IRR, and payback period. The net present value of alternative-3 is $65,795.65, which is highest among all. Further, the IRR of alternative-3 is 14.96%, which is also higher than the other two alternatives. The payback period of alternative-3 is 4.39 years which is the lowest among all. Therefore, it is recommended to the management of Needles Manufacturing that they should replace the old machine with the Camn machine.
References
Ehrhardt, M and Brigham, E. 2008. Corporate Finance: A Focused Approach. Cengage Learning.
Gitman. 2007. Principles of Managerial Finance, 11/E. Pearson Education India.
Shapiro. 2008. Capital Budgeting and Investment Analysis. Pearson Education India.
Essay Writing Service Features
Our Experience
No matter how complex your assignment is, we can find the right professional for your specific task. Contact Essay is an essay writing company that hires only the smartest minds to help you with your projects. Our expertise allows us to provide students with high-quality academic writing, editing & proofreading services.Free Features
Free revision policy
$10Free bibliography & reference
$8Free title page
$8Free formatting
$8How Our Essay Writing Service Works
First, you will need to complete an order form. It's not difficult but, in case there is anything you find not to be clear, you may always call us so that we can guide you through it. On the order form, you will need to include some basic information concerning your order: subject, topic, number of pages, etc. We also encourage our clients to upload any relevant information or sources that will help.
Complete the order formOnce we have all the information and instructions that we need, we select the most suitable writer for your assignment. While everything seems to be clear, the writer, who has complete knowledge of the subject, may need clarification from you. It is at that point that you would receive a call or email from us.
Writer’s assignmentAs soon as the writer has finished, it will be delivered both to the website and to your email address so that you will not miss it. If your deadline is close at hand, we will place a call to you to make sure that you receive the paper on time.
Completing the order and download