Capital Budgeting and Investment Appraisal: An Analysis of NPV and IRR

NPV and IRR

Required: Your report should address the following requirements:

(A) Calculate the Net Present Value and Internal Rate of Return of the proposed investment and provide a recommendation on the proposed investment. Using academic literature, provide critical analysis of these two advanced approaches of making capital budgeting decisions. (50%)

(B) Using appropriate academic literature, provide critical analysis of the developments and applications of ‘sophisticated capital budgeting practices. (20%)

(C) Using appropriate academic literature, provide critical analysis of the effect of uncertainty and irreversibility on capital budgeting decisions in practice. (20%)

10% of the total marks is reserved for the overall presentation of your report.

The report needs to be approximately 1,500 words (excluding tables, graphs, references and appendix) and should follow the recommended structure as below. Use the Harvard style for referencing and citations. Ensure your excel calculations are presented in the body of the report in the form of picture (enhanced metafile).

 Recommended Structure:

Front Page with word count - Table of Content - Introduction (150 words)

Section A: NPV and IRR (400 words) - Section B: Sophisticated capital budgeting practices (400 words) - Section C: Effect of uncertainty and irreversibility (400 words)

Overall conclusion (150 words)

References

Appendix (If required)

Background/Context
Background: Alzahraa Ltd. is a new company founded by Mariam which manufactures one car part called “Moto”. The company has just completed its first few years of operation and has experienced moderate growth. Mariam wishes to increase the sales of “Moto” and is planning to invest in a new machine which will require investment costing £50,000. At the end of its lifetime (5 years), the machine can be sold to scrap for £6,000 in present value terms. Mariam expect to sell 4,000 units of “Moto” in the coming year and the demand is expected to increase by 20% in each of the following two years, and then by 10% in each of the subsequent two years.
The current selling price of “Moto” is £240 per unit and this is expected to inflate by 5% per annum. The variable costs is £160 per unit in current terms and the incremental fixed costs are expected to be £52 per unit in current terms. Both of these costs are expected to inflate at 10% per annum. This project requires working capital investment equal to 20% of the expected sales revenue; this investment must be in place at the start of each year. The corporation tax rate for Alzahraa Ltd. is at 15% per annum and is paid one year in arrears. 30% reducing balance writing-down allowances are available on the machinery cost. Mariam expects an immediate initial cost of £10,000 for training existing staff on the new machine. Alzahraa Ltd. uses a nominal (money terms) after-tax cost of capital of 8% for investment appraisal purposes.
You have been recently hired at Alzahraa Ltd. as the trainee Management Accountant and have been asked to draft an academic report in a manner suitable for presenting to Mariam, who himself has a sound academic background. Your report has to make use of relevant books and academic journals to rationalise your claims and recommendations. You have been specifically briefed to avoid using web sources to support your claims.