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## Evaluation of Different Alternatives under Three Methods of Project Evaluation

The project appraisal is a structured approach which starts from estimating the future cash inflows and outflows and ends with determining the financial viability of the project. There are different methods being used in assessing the project’s financial viability such as net present value, internal rate of return, and payback period. Each method has its own peculiarities and therefore, none of these can be said to be superior to the other (Ehrhardt and Brigham, 2008). It depends upon the situation as to which method is to be applied in assessing the project’s financial viability. In this context, this report has been prepared for Needle Manufacturing to analyze three alternatives in regard to the machine replacement decision. There are three different machines being considered to replace the current one.

Net Present Value Method

The net present value method is the most commonly applied method for the purpose of evaluation of the project’s financial viability. Under this method, the net present value is computed by deducting the present value of all cash outflows from the present value of cash inflows of the project. The project having highest positive net present value is considered the most appropriate and hence selected for implementation (Ehrhardt and Brigham, 2008). The net present value method produces analysis of profitability of the project which is primary advantages of this method. It becomes easier to measure the contribution of project to the shareholder’s worth by analyzing the project under net present value method. The biggest disadvantage of net present value method is that it does not fit for analysis when the projects being analyzed are of different sizes. Further, the analysis of net present value also does not provide the rate of return earned by the investors as provided by the internal rate of return method (Ehrhardt and Brigham, 2008). In regards to the Needle Manufacturing, the analysis of the net present value of three different machines is presented in the tables given below:

 Alternative-1: Alph Machine Year Description Amount (£) PVF@10% Present Value (£) 0 Initial Outlay (500,000.00) 1.0000 (500,000.00) 1 Cash inflow 50,000.00 0.9091 45,454.55 2 Cash inflow 100,000.00 0.8264 82,644.63 3 Cash inflow 150,000.00 0.7513 112,697.22 4 Cash inflow 150,000.00 0.6830 102,452.02 5 Cash inflow 150,000.00 0.6209 93,138.20 6 Cash inflow 170,000.00 0.5645 95,960.57 Present Value 32,347.18
 Alternative-2: Beat Machine Year Description Amount (£) PVF@10% Present Value (£) 0 Initial Outlay (500,000.00) 1.0000 (500,000.00) 1 Cash inflow 200,000.00 0.9091 181,818.18 2 Cash inflow 150,000.00 0.8264 123,966.94 3 Cash inflow 150,000.00 0.7513 112,697.22 4 Cash inflow 50,000.00 0.6830 34,150.67 5 Cash inflow 25,000.00 0.6209 15,523.03 6 Cash inflow 25,000.00 0.5645 14,111.85 Present Value (17,732.10)
 Alternative-3: Camn Machine Year Description Amount (£) PVF@10% Present Value (£) 0 Initial Outlay (500,000.00) 1.0000 (500,000.00) 1 Cash inflow 150,000.00 0.9091 136,363.64 2 Cash inflow 150,000.00 0.8264 123,966.94 3 Cash inflow 150,000.00 0.7513 112,697.22 4 Cash inflow 150,000.00 0.6830 102,452.02 5 Cash inflow 100,000.00 0.6209 62,092.13 6 Cash inflow 50,000.00 0.5645 28,223.70 Present Value 65,795.65

The results of the analysis conducted above depicts that the alternative-1 with Alph Machine is yielding a net present value of \$32,347.18. The alternative-2 with Beat Machine is yielding net present value of \$-17732.10 while the alternative-3 with Camn machine is yielding net present value of \$65,795.65. It could be observe that the alternative-3 with Camn machine is yielding the highest net present value. Therefore, based on the net repent value it could be analyzed that the alternative-3 would be first choice in front of the management for replacement of the old machine.

## Net Present Value Method

The internal rate of return (IRR) method provides computation of the rate of return that the investor will yield on the amount invested (Gitman, 2007). This method is considered superior than the accounting rate of return because it takes into consideration the time value of money. In the internal rate of return method, the project’s IRR is compared with the company’s required rate of return and the project yielding highest IRR is considered the best for implementation. The internal rate of return method is simple in interpreting the results and understanding the outcome. However, it may be computationally very difficult in the situations of unconventional cash flows. In the cases when the stream of cash flows involves both cash inflows as well as outflows over the entire period of the project, the computation of IRR becomes difficult. Further, the analysis of different size projects by applying IRR method is not considered appropriate (Gitman, 2007). In regard to Needle Manufacturing, the computation of IRR for all three alternatives is given as below:

 Alternative-1: Alph Machine Year Description Amount (£) 0 Initial Outlay (500,000.00) 1 Cash inflow 50,000.00 2 Cash inflow 100,000.00 3 Cash inflow 150,000.00 4 Cash inflow 150,000.00 5 Cash inflow 150,000.00 6 Cash inflow 170,000.00 IRR 11.86%
 Alternative-2: Beat Machine Year Description Amount (£) 0 Initial Outlay (500,000.00) 1 Cash inflow 200,000.00 2 Cash inflow 150,000.00 3 Cash inflow 150,000.00 4 Cash inflow 50,000.00 5 Cash inflow 25,000.00 6 Cash inflow 25,000.00 IRR 8.23% Alternative-3: Camn Machine Year Description Amount (£) 0 Initial Outlay (500,000.00) 1 Cash inflow 150,000.00 2 Cash inflow 150,000.00 3 Cash inflow 150,000.00 4 Cash inflow 150,000.00 5 Cash inflow 100,000.00 6 Cash inflow 50,000.00 IRR 14.96% Alternative-1: Alph Machine Year Description Amount (£) PVF@10% Present Value Cumulative PV 0 Initial Outlay (500,000.00) 1.0000 (500,000.00) 1 Cash inflow 50,000.00 0.9091 45,454.55 (454,545.45) 2 Cash inflow 100,000.00 0.8264 82,644.63 (371,900.83) 3 Cash inflow 150,000.00 0.7513 112,697.22 (259,203.61) 4 Cash inflow 150,000.00 0.6830 102,452.02 (156,751.59) 5 Cash inflow 150,000.00 0.6209 93,138.20 (63,613.39) 6 Cash inflow 170,000.00 0.5645 95,960.57 32,347.18 Payback Period (Years) [5+63613.39/95960.57] 5.66 Alternative-2: Beat Machine Year Description Amount (£) PVF@10% Present Value Cumulative PV 0 Initial Outlay (500,000.00) 1.0000 (500,000.00) 1 Cash inflow 200,000.00 0.9091 181,818.18 (318,181.82) 2 Cash inflow 150,000.00 0.8264 123,966.94 (194,214.88) 3 Cash inflow 150,000.00 0.7513 112,697.22 (81,517.66) 4 Cash inflow 50,000.00 0.6830 34,150.67 (47,366.98) 5 Cash inflow 25,000.00 0.6209 15,523.03 (31,843.95) 6 Cash inflow 25,000.00 0.5645 14,111.85 (17,732.10) Payback Period (Years) 6.00
 Alternative-3: Camn Machine Year Description Amount (£) PVF@10% Present Value Cumulative PV 0 Initial Outlay (500,000.00) 1.0000 (500,000.00) 1 Cash inflow 150,000.00 0.9091 136,363.64 (363,636.36) 2 Cash inflow 150,000.00 0.8264 123,966.94 (239,669.42) 3 Cash inflow 150,000.00 0.7513 112,697.22 (126,972.20) 4 Cash inflow 150,000.00 0.6830 102,452.02 (24,520.18) 5 Cash inflow 100,000.00 0.6209 62,092.13 37,571.95 6 Cash inflow 50,000.00 0.5645 28,223.70 65,795.65 Payback Period (Years) [4+24520.18/62092.13] 4.39

The results of the analysis presented above show that the payback period of alternative-1 with Alph machine is 5.66 years. Further, the payback period of alternative-2 with Beat machine has been found to be 6 years. It could be observed that the initial outlay is not even getting recovered fully in 6 years time period in case of alternative-2. The cash outflow of \$17,732.10 is remaining at the end of 6th year unrecovered. Further, in the case of alternative-3, the payback period has been found to be 4.39 years. It could be observed that the payback period of alternative-3, is the lowest which implies that this alternative is the best choice for the management.

From the analysis of all three alternatives, it has been observed that the alternative-3 with Camn machine is the best choice available for the management for replacement of the old machine. The alternative-3 has dominated the other two alternatives in the analysis of net present value, IRR, and payback period. The net present value of alternative-3 is \$65,795.65, which is highest among all. Further, the IRR of alternative-3 is 14.96%, which is also higher than the other two alternatives. The payback period of alternative-3 is 4.39 years which is the lowest among all. Therefore, it is recommended to the management of Needles Manufacturing that they should replace the old machine with the Camn machine.

References

Ehrhardt, M and Brigham, E. 2008. Corporate Finance: A Focused Approach. Cengage Learning.

Gitman. 2007. Principles of Managerial Finance, 11/E. Pearson Education India.

Shapiro. 2008. Capital Budgeting and Investment Analysis. Pearson Education India.

Cite This Work

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[Accessed 05 August 2024].

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