Introduction
Each and every organization undertakes accounting measures to assess the level of its performance and to make control over unnecessary activities or expenses (Koh and Lee, 2015). It enables the firm to make appropriate financial decisions which make contribution in the achievement of organizational aim and objectives (Kaplan and Atkinson, 2015). Besides this, investment appraisal technique such as net present value method helps company in making more profitable decisions. It provides deeper insight to an organization about the return which they get over a predetermined time frame (Investment appraisal techniques, 2015). It enables company to build and sustain competitive edge over others. This report depicts the net present value of investment which helps company in suitable investment decision.
Scenario: Manager of an organization already made investment in 20 projects in which 30% of new products failed to achieve the expected NPV. The new investment which corporation is going to make will have no such impact upon the sales. Senior management has identified that previous forecast is too optimistic. Thus, in new investment, senior management of company considers the higher discounting rate so as to become able to achieve their desired output.
Net present value
It is also termed as NPV which depicts the present value of inflow and outflow of cash over a period of time. This method of investment appraisal considers time value of money concept which states that time factor closely impacts the value of cash flow (What is net present value?, 2015). NPV method provides more assistance in determining that whether the investment will result into profit or loss (Bedford and Malmi, 2015). It enables the organization to make suitable decisions that whether investment is suitable or not for the further organizational growth and development (He, Wang and Liu, 2015).
Through this, company can choose the most profitable investment which maximizes its profits and market share (Niblock and Sloan, 2015). In order to calculate the net present value of an investment, corporation compares the present value of money from its future value (Oates, 2015). This method also takes into consideration the rate of inflation which also makes impact upon the return which enterprise gets from an investment (Yu and et.al., 2015). In addition to this, net present value method takes into account the discount rate which acts as a key variable in this method. Discount rate consists of the rate which enterprise might earn if it invests this money in other alternative project (Callaghan and Papageorgiou, 2015).
This method proves to be more effective because it enables the enterprise to make comparison between two or more projects (Essen and et.al, 2015). Through this, company is able to select the project which gives higher and positive return to the firm (Malhotra, 2015). It acts as a tool which helps organization in assessing the contribution of dollar upon several stockholders (Advantages & Disadvantages of Net Present Value in Project Selection, 2015).
| Discount rate | 11.00% |
| Initial investment | 1400000 |
| Product life cycle | 5 Years |
Calculation of cash inflow and cash outflow
Annual Volume = 90000
| Year | Selling price per unit | Total sales | Material cost per unit | Labor cost per unit | Material & labor cost per unit | Total cost | Annual overheads | Total expenditure |
| 2016 | 97.00 | 8730000.00 | 41.00 | 14.00 | 55.00 | 4950000.00 | 1400000.00 | 6350000.00 |
| 2017 | 99.91 | 8991900.00 | 41.82 | 14.28 | 56.10 | 5049000.00 | 1400000.00 | 6449000.00 |
| 2018 | 102.91 | 9261657.00 | 42.66 | 14.57 | 57.22 | 5149980.00 | 1400000.00 | 6549980.00 |
| 2019 | 105.99 | 9539506.71 | 43.51 | 14.86 | 58.37 | 5252979.60 | 1400000.00 | 6652979.60 |
| 2020 | 109.17 | 9825691.91 | 44.38 | 15.15 | 59.53 | 5358039.19 | 1400000.00 | 6758039.19 |
Calculation of Net cash flow
Net cash flow = Cash inflow - cash outflow
| Year | Cash inflow | Cash outflow | Net cash flow |
| 2016 | 8730000.00 | 6350000.00 | 2380000.00 |
| 2017 | 8991900.00 | 6449000.00 | 2542900.00 |
| 2018 | 9261657.00 | 6549980.00 | 2711677.00 |
| 2019 | 9539506.71 | 6652979.60 | 2886527.11 |
| 2020 | 9825691.91 | 6758039.19 | 3067652.72 |
Calculation of Net present value
| Year | Net cash flow | PV factor @ 11% | Present value |
| 2016 | 2380000.00 | 0.90 | 2144144.14 |
| 2017 | 2542900.00 | 0.81 | 2063874.69 |
| 2018 | 2711677.00 | 0.73 | 1982754.85 |
| 2019 | 2886527.11 | 0.66 | 1901444.82 |
| 2020 | 3067652.72 | 0.59 | 1820502.58 |
- Total present value 9912721.08
- Less Initial investment 14000000.00
- Net present value -4087278.92
From the above mentioned calculation, it has been interpreted that cash inflow of enterprise is greater than the outflow of cash. Due to increasing rate of inflation, cost of material and labor continuously increases which may the cause of high inflow of cash. Besides this, selling price of products or services also increases by 3% per year. Due to these factors, price of the products or services get increased. It closely impacts the profitability aspects of an organization.
Moreover, customers switch to the substitute products whenever prices of products or services are increased. It closely hampers the brand image and market share of enterprise. Thus, total present value is less than the initial investment made by company (Guthrie and Lemon, 2014). Net present value of an investment is negative so it is recommended to the organization that it should not invest 1400000£ in this project. This project is not suitable from the point of view of organizational growth and development (Dagiliene, 2015).
It has been assessed that gap between total present value and initial investment is huge such as -4087278.92. Thus, firm requires to reject this proposal and make efforts to identify as well grab the other most profitable opportunities. Therefore, organization needs to makes investment in that project which provides higher return to the organization (Haselip, Desgain and Mackenzie, 2015).
CONCLUSION
It can be concluded that measures of accounting performance and control plays a significant role in achieving success in the dynamic business arena. Investment appraisal technique provides guidance to company in relation to the selection of investment. It can be seen in the report that net present value of investment is negative. Thus, organization should not make investment in the new project because it is not beneficial for the organization. Net present value method provides more assistance to the finance manager in making appropriate decisions which aids in the productivity and profitability of a company.
REFERENCES
- Bedford, D. S. and Malmi, T., 2015. Configurations of control: An exploratory analysis. Management Accounting Research. 27. pp. 2-26.
- Callaghan, C. and Papageorgiou, E., 2015. Gender differences in locus of control and student performance in the South African context of accounting studies. Meditari Accountancy Research. 23(3). pp. 348-368.
- Dagiliene, L., 2015. THE INVESTIGATION OF FINANCIAL REPORTS’COMPLEXITY IN LARGE COMPANIES. Economics and Management. (14). pp. 28-32.
- Essen, M. and et.al., 2015. How does Family Control Influence Firm Strategy and Performance? A Metaâ€ÂAnalysis of US Publicly Listed Firms. Corporate Governance: An International Review, 23(1). pp. 3-24.
- Guthrie, G. and Lemon, L. D., 2014. Mathematics of interest rates and finance. Pearson Higher Ed.
- Haselip, J., Desgain, D. and Mackenzie, G., 2015. Non-financial constraints to scaling-up small and medium-sized energy enterprises: Findings from field research in Ghana, Senegal, Tanzania and Zambia. Energy Research & Social Science. 5. pp. 78-89.
- He, Z., Wang, N. and Liu, R., 2015. The Multi-Mode Capital-Constrained Net Present Value Problem. In Handbook on Project Management and Scheduling. Springer International Publishing.
- Kaplan, R. S. and Atkinson, A. A., 2015. Advanced management accounting. PHI Learning.
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