Introduction
Every organization undertakes accounting measures to assess the level of its performance and to gain control over unnecessary activities or expenses (Koh and Lee, 2015). It enables the firm to make appropriate financial decisions which make contribute to the achievement of organizational aims and objectives (Kaplan and Atkinson, 2015). Besides this, investment appraisal technique such as the net present value method helps a company in making more profitable decisions. It provides deeper insight into an organization about the return that they get over a predetermined time frame (Investment Appraisal Techniques, 2015). It enables a company to build and sustain a competitive edge over others. This report depicts the net present value of investment which helps the company in suitable investment decisions.
Scenario: The manager of an organization already invested in 20 projects in which 30% of new products failed to achieve the expected NPV. The new investment that the corporation is going to make will have no such impact on the sales. Senior management has identified that the previous forecast is too optimistic. Thus, in new investment, senior management of the company considers the higher discounting rate 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 while. This method of investment appraisal considers the time value of money concept which states that the time factor closely impacts the value of cash flow (What is the net present value?, 2015). NPV method provides more assistance in determining whether the investment will result in profit or loss (Bedford and Malmi, 2015). It enables the organization to make suitable decisions as that whether an investment is suitable or not for further organizational growth and development (He, Wang, and Liu, 2015).
Through this, a company can choose the most profitable investment which maximizes its profits and market share (Niblock and Sloan, 2015). To calculate the net present value of an investment, a corporation compares the present value of money with its future value (Oates, 2015). This method also takes into consideration the rate of inflation which also impacts upon the return that an enterprise gets from an investment (Yu and et.al., 2015). In addition to this, the net present value method takes into account the discount rate which acts as a key variable in this method. The discount rate consists of the rate that an enterprise might earn if it invests this money in other alternative projects (Callaghan and Papageorgiou, 2015).
This method proves to be more effective because it enables the enterprise to make comparisons between two or more projects (Essen and et.al, 2015). Through this, the company can select the project that gives higher and positive returns to the firm (Malhotra, 2015). It acts as a tool that helps organizations in assessing the contribution of dollars to 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 the cash inflow of the enterprise is greater than the outflow of cash. Due to the increasing rate of inflation, the cost of material and labor continuously increases which may be the cause of the high inflow of cash. Besides this, the selling price of products or services also increases by 3% per year. Due to these factors, the price of the products or services increases. It closely impacts the profitability aspects of an organization.
Moreover, customers switch to substitute products whenever the prices of products or services are increased. It closely hampers the brand image and market share of the enterprise. Thus, the total present value is less than the initial investment made by the company (Guthrie and Lemon, 2014). The 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 the gap between total present value and initial investment is huge such as -4087278.92. Thus, the firm is required to reject this proposal and make efforts to identify as well as grab the other most profitable opportunities. Therefore, the organization needs to make investments in that project which provides higher returns to the organization (Haselip, Desgain and Mackenzie, 2015).
CONCLUSION
It can be concluded that measures of accounting performance and control play a significant role in achieving success in the dynamic business arena. The investment appraisal technique guides the company in the selection of investment. It can be seen in the report that the net present value of the investment is negative. Thus, the organization should not invest in the new project because it is not beneficial for the organization. The 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 IS COMPLEX 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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