Impact of Finance on Business Decisions

Introduction

In this assignment I will be looking at two businesses’s which will need to be compared to find out which method it should be taken. These calculations will show me what way they should go so it would benefit them profitably wise, either on a long or short-term basis. The calculations would show me the term for 3 years and what I will be making and what I will be losing. From the calculations calculated I will make a decision on what stages could be best suitable for them to make the payback.

The business Lee Ltd has the funds to put forward for a “Transport Project” or a “New Networking Project”. It is up to them to see what project is best suitable for them and which one they would go for. The firm has a decision whether they want to go along with Transportation or Network Project the figures show…

Appraisal Methods

For every business to know where they should invest their money it is essential to research what they should do. This is either by investing in a long term project, invest in a machinery to see whether that equipment will come to any use and provide goods more then it actually cost. There are different types of appraisal methods which include…

* NPV (Net Present Value)

* PBP (Payback Period)

* ARR (Account Rate of Return)

Calculations

Transport Project –

NPV (Net Present Value)

Net Cash Savings 14% Discount

Year 1 – 38,800 x 0.8772 = 34,035

Year 2 – 41,400 x 0.7695 = 31,857 Discount Figure – Investment

Year 3 – 44,800 x 0.6750 = 30,240 154,630.80 – 150,000 =

Year 4 – 50,200 x 0.5921 = 29,723 4,630.80

Year 5 – 55,400 x 0.5194 = 28,774 Total

PBP (Payback Period)

Initial Investment Net Cash Savings Payback Period

Year 1 – 150,000 38,800 111,200

Year 2 – 111,200 41,400 69,800

Year 3 – 69,800 44,800 25,000

Year 4 – 25,000 50,200 -25,200

Year 5 – 55,400

ARR (Account Rate of Returns)

Net Cash Savings Expected Average Profits

Year 1 – 38,800

Year 2 – 41,400 Total Net Cash Savings 230,000

Year 3 – 44,800

Year 4 – 50,200 Years 5

Year 5 – 55,400

Total 46,120

Total – 230,600

Account Rate of Return

Expected Average Profit 46,120

X 100 x 100 = 30.747

Initial Investment 150,000

What the Calculation Mean?

NPV (Net Present Value) – From working out the NPV this shows me the present value of taking on the project, the way you work this out is by…

A percentage is worked out as it is 14% after when the decimal figures is calculated it is multiplied by the Net Cash Savings, this then worked out for the 5 years.

As the investment sum is 150,000 this is subtracted by the total of the Discounted Figure of 154,630.80 to give the total which is known as the NPV.

PBP (Payback Period) – This is a very interesting process in a business which can know a figure of which they have to return. It shows how long it takes for the money to be given back and how much which is usually subtracted from the initial investment. By working out the payback period for all years it comes to a point where nothing is able to be paid back as it is paid off. This is where the figure decreases towards 0 then passes the point and starts to raise. In this table of PBP it shows us that the amount starts to rise again in Year 4. My estimation for this is that it took 3 years and 6 months.

I have come to this conclusion because in Year 3 the amount left to payback was 25,000 and then in Year 4 it then became -25,000, this shows that the figure had gone pass the 0 point so it had made 50,200. So to my calculations it shows that in the middle of the year it had gone pass the 0 point and had paid back all the money.

ARR (Account Rate Return) – This method shows how much percent the business owes. It is a good explanation for working out what amount is going.

The ARR is calculated by taking the Expected Average profits and dividing it by the Initial Investment. Before working out the calculation the Expected Average Profit needs to be calculated, this is by adding up all the Net Cash Savings and dividing the total by the amount of years. By working out the figure it showed that the Account Return Rate was 30.747% for the finance returned

Strengths and Weaknesses for Investment Appraisal

NPV Advantages –

* This is a good way of finding out what method is realistic and how much value its cash would give them.

* It is a clear way of showing the future’s capital.

* Not Hard to work out but a calculation needed with expertise.

Disadvantages –

* The discount percent is made up by the organisation.

* Estimate is not always correct.

* It is the hardest method to calculate.

PBP Advantages –

* This way of calculating finances is simple and quick to understand

* This method is helpful to work out any liquidity issues

* The shorter the payback period the safer the business

* Not hard to plot

Disadvantages –

* After payback periods have been settled the cash flow is not looked upon properly.

* No profitability is subject to the investment of the method.

ARR Advantages –

* All the cash flow is recorded for the entire investment

* No consequences are indicated for cash flow and profitability in the investment.

Disadvantages –

* When ever the cash flow is determined no recording are taken

* Whether the money has decreased in value it is not looked upon.

Conclusion for which Project Chosen

From the calculations it shows that the Transport Project is worth going for, but with the 150,000 Lee Ltd have another option which they could use if they think the transport is not worth wile. Lee Ltd has the option to invest their money in a new Networking Project which they could get to improve their old one.

As the figures show Lee Ltd that the NPV is more then the networking project from 130.80. The Networking Project has a NPV of 4,500 and the transport project have a NPV of 4630.80. This shows that the NPV on the 1st project of transport is better and greater where they make more returns.

Also another downfall for the Networking Project is that the ARR for that is 25% which is way less then the 1st project of 30.747%. This shows that the sales return they are receiving by the network project is much les then the transport project.

But the transport project has 1 downfall to the investment plan as its payback period for the time is 3 year and 6 months, where as the networking project is only 3 years. It isn’t always the fact that a business should see that if they pay off their debt early they would make a profit but to see how it would benefit them in the long run. If Lee Ltd is looking to put their investment into a short-term basis schedule then the Networking Project is ideal, but looking from the figures it shows us that on the long run the transport project will be best for them to go ahead with.

As it had been mentioned before that the transport project is more reasonable to go ahead with as calculations presented showed clear understanding of the NPV, ARR and PBP. But to be sure all the calculation wee not precise but estimates, this can effect many aspects in a business world as everything is not precise as petrol prices may vary and increase in taxation. All this is not listed in calculations they carry out but they are predicted as estimates.

Benefit for Transport Project

The benefit Lee Ltd would get from investing in the Transport Project is that they could run 24 hour shifts to get good out to customers and not rely on firm vehicles. The problem with vehicles rented is that if any damage is caused then charges are high. Being able to deliver goods on time also makes a difference as it leaves customers satisfied. Advertisements cold be made on their own vehicles which would increase publicity.

Benefits of Network Project

There are many benefits of investing in a network project as they could make the accounting easy as it would not require high level of skill to do them. Having a well updated network would help Lee Ltd to get their business online and be able to sell goods on the internet. This would lead to a 24 hour service available to everyone.

Conclusion

The conclusions which I have decided for the project to be invested in would be the transport project as it shows better reasonable calculation from the NPV and ARR. These aspects show that Lee Ltd would get a higher rate in return if they were to keep the investment continued for a longer basis. If the PBP is longer the Networking Project this would not make a lot of difference as to paying back period.

The idea of having the Networking Project is not bad as this would help them in the future to get their business online and be able to publicise their business.