Financial Budget Appraisal Essay
Fortunately or unfortunately, there are two option involved and four capital investment appraisal to choose from for their desired project. This paper will purpose to analyze these two options and recommend the Z125 as the best one giving reasons. According to Rossi (2015), capital investment appraisal also referred to as capital budgeting can be defined as the process by which companies get to decide on the investment which is most profitable and is worth the company’s capital (P. As such, this process is crucial as it is concerned with the company’s future. Also, a number of techniques and practices are involved in this particular process. In addition, the payback period focuses on how fast the project or the investment can pay back the initial investment, which simply the measure of risk (Brealey et al.
Since every company wants to generate profits fast, using the payback period, it can be able to invest in a lot of projects that will return more than it cost. Using the ARR and the initial capital investment, the management of a company can use the information gathered to compare projects and make a decision. However, ARR has limitations similar to the payback period, both of the techniques do not give the TVM attention and the cash flows timing. Thus, ignoring some of the firm’s policies on accounting which would affect the profits generated. Furthermore, the G120 plan has a higher return rate. The Z125 requires the company to invest in using its major capital budget of £3,232,000 for 3 years while the G120 requires only £1,112,000 for two years.
The G120 option has a faster payback and a lower initial investment which makes it the better option for a low investment. However, these factors only are not adequate in the making of a viable decision. In actual sense, most companies go for NPV and the IRR when considering investments. et al. Looking at the statistics made by the company, the NPV in Z125 is higher than that of the G120 which makes it the best option the company can choose even though this metric has some drawbacks. If the company happens to miscalculate the discount rate, it will not be noticed until the investment has turned into a pool of losses and it’s a disappointment. The other shortcoming is that the payback period does not take into account the initial capital cost and the inflation account (Wheelen and Hunger, 2012).
Also in the payback period method, any cash flow that was not included in the timeline will not be considered even if it is substantial. G120 Z125 Initial capital investment 1. 112m Pounds 3. 232m Pounds New engine cost 2. 08m Pounds 2. 08m Pounds Total amount 3. Also, the paper has considered the various outcome of each options including the decision by the Technical Director to purchase a new engine. As seen above the company does not have enough capital as it is to purchase a new engine using the Z125 option but if the company were to choose from the best option to choose from, the Z125 would have been the best option as it is a high investment, with huge returns and a higher NPV.
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