Table of Contents
A) Comparison and recommendation of the most preferred capital investment appraisal system
Upon presentation of the five projects by Adventure Ventures Limited a number of capital appraisal systems needs evaluation. Payback and Net Present Value need evaluation to determine which method will suit the calculation of the company’s investment. Payback period is the easiest way of investment appraisal technique. It is defined as the time expected for the business to recover the investments outflow from inflows of the same investment. Net present value presents the outgoing and incoming cash flow and the present value of the some entities. In case of flowing future cash flow and with an outflow of purchases only the net present values is calculated by subtracting cash flow from purchases (May, 2007).
Net Present value
This method is used in calculation of a project lasting for a long period. Present value can be determined by subtracting the cash flow from purchases when the investment has purchases as the only cash out flow. This method also provides important of the value of money in particular time. The value of money can appreciate or depreciate and this method works in respect of the value (Samuel, 2009). In case of using this method, Adventure Venture Limited will be able to work with respect of money value. The five projects will take three years and money value can appreciate or depreciate. This method will ensure effective determination of the present values in respect of the currency value.
Another advantage is the determination of cash flow before the project and after the project. This method allows consideration of cash flow after, before and during the life span of the project. In case of application of this method, the company will be able to determine the cash flow it had before the start of the five projects and the amount it will have after three years. Another advantage of using net present values is the priority given to profitability and risk. Some method does not consider the risks arising and incase of risk the project collapse. Application of this method will ensure that the project maximizes the profit and prepares for recovery of disaster. This method will ensure continuity of the project despite the risks which might arise (Jonathan, 2011).
Finally, net present value will assist in maximizing the company’s value. It will ensure that there are no funds misused. All funds generated from the project will be budgeted to ensure continuity of the project (Buser, 2010). Those are the advantages of using net present value by Adventure Venture Limited.
There a number of disadvantages accompanied by this method of capital investment appraisal. The method is difficulty to use. The projects need involvement of professional in order to ensure effectiveness application. In case the company uses this method it will need to employ professional, who will be making the calculations (Grier, 2008). In case the company will not be willing to incur extra fee in wages it can contract professional who will be making the evaluation at a particular time either yearly or monthly. The method will force the company to add extra money for financing calculation services. The method is difficulty and the person calculating can end up with wrong figures. This will lead to collapse of the project because it will operate outside budget. In case of dishonest employees, the company will also incur loss due to fraud.
The projects do not have equal funds, and this will lead to inaccurate decision. If the projects had similar amount this method could have been the most appropriate. Calculation of discount rate using this method is difficulty. This can lead to incorrect figures leading to collapse of the project before the expiry period. The last disadvantage with net present value is that, it gives incorrect decision when the project has different life span. Though the project has the same life span it will not be appropriate (Buser, 2010). This method can lead collapse of the project before the end of the three years. It will lead to inaccurate decision because of the difference in investment fund. The method is also difficulty to calculate, and this can lead to incorrect figures hence collapse of the project. Though net present value has advantages, the disadvantages can lead to collapse of the project before the end of the three years period.
Payback is another method which can be used by the Adventure Venture Limited. This method is appropriate to calculate capital investment for projects lasting for a long period. Calculation of the payback period is determined by cash flow per period. When the cash flow is even the payback period is calculated by dividing initial investments by cash flow in a given period. In case of uneven cash flow the payback period is calculated by diving absolute value of cash flow by actual cash flow and adding the value with the last time with a negative cash flow (Grier, 2008).
It is simple in calculation. Calculation can be done by anybody in the organization after getting the formula. Adventure Venture Limited will not need to hire professional like when using net present value. The manager can do the calculation. It will not incur expenses which it could have incurred while paying professional to do the calculation. It can be used as a measure of risk (May, 2007). It determines the cash flows which occur during the projects life, and this can be used to determine the risks occurring. Mitigation of those risks will take place and ensure continuity of the project to the expiry period. In case of liquidity, this method provides an alternative of projects which can help in recovery of money early. This method ensures continuity of the project. It ensures that the project does not collapse before the expiry of the set period.
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The method has few disadvantages which makes it inappropriate. This method does not consider the value of money in given time. This can lead to making of wrong decision and later collapse of the project before the expiry period (Buser, 2010). Though it has this disadvantage there is a way to encounter the problem called discounted payback method. This helps to ensure that the method does not lead to end of the project before the set period. The method does not consider the cash flow which occurs after reaching the payback period.
This method is the most applicable to be used by Adventure Venture Limited. It will safe the company the cost of calculation and also ensures continuity of the project for three years. Unlike net present values, this method will ensure proper calculation of discount and help in decision making. Calculation is easy, and this means that even the managers can calculate anytime to determine the progress of the project (Jonathan, 2011).
B) Assessment of the five projects
|project||Capital Expenditure(2013)||Project net cash flow 2013||2014||2015|
The table above represents the five projects and the cash flow for the three years.
The first project, “Scamble’ will have a capital expenditure of 3,520 in 2013 and cash flow of 2,080 in 2013, 1,560 in 2014, and 1,040 in 2015. The total cash flow for the three years will be 4620. The total investment is 3,520, and this divided by the total cash flow will be 0.76.
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The second project, “Gybe-oh!” will have an expenditure of 3,280 at the beginning of 2013. The cash flow for 2013 is 1,540, 1014 is 1,540 and for 2015 is 1,540. The total cash flow for the three years will be 4,620. Total cash flow divided by expenditure will be 0.7.
The third project, “Rappel” will have a capital expenditure of 2260 by beginning of 2013. The project net cash flow for 2013 will be 2,080, 2014 will be 1,560 and 2015 will be 1,040. This will bring about a sum of 4,140 during the expiry of the period. The sum divided by investment will give a total of 0.5.
The fourth project, “Nautilus” will have a total expenditure of 2,060 in 2013. The cash flow will be 1,480 in 2013, 480 in 2014 and 1,180 in 2015. The sum for the three years cash flow is 2,880. The sum divided by investment is 0.78.
The final project, “Bounce” will have the little amount to operate. The total expenditure will be 560 in 2013. The cash flow for 2013 is 200, 2014 is 260 and 2015 is 200. The total cash flow for those years is 660. This divided by the investment amount in 2013 will be 0.8.
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Using payback method a project should not be accepted if the payback period is large than target payback period. Project number one has a payback period of 7 and half month. The second project has a payback period of seven month and project three is five month. The fourth project has a payback period of seven and a eighth month while the last project has a payback period of eight month. According to the rule of payback period calculation none of the projects will be accepted.
The five projects will not continue, because they have a payback period less than the target payback period. The payback period target is three years and none of the project qualifies. The company should stop investing in the project and start new projects.