Report And Recommendations For Motors Engineering LTD Essay Example

to replace a piece of capital equipment.

When deciding between different types of investments, it is important to carefully consider the options available.

Determining the optimal financing options, such as weighing the pros and cons of leasing versus purchasing.

When making business decisions, it is crucial to consider both quantitative and qualitative factors. Financial evaluation plays a significant role in determining the feasibility of investing in a capital project. However, there are other important considerations as well, such as assessing potential risks and rewards, recognizing the intangible benefits of a specific project, evaluating its alignment with the company's strategic goals, analyzing liquidity and impact on shareholders' returns. Furthermore, legal, ethical, political, personnel, and quality-related matters should also be taken into account.

According to McKenzie (1994, p235), when financial analysis is combined with an existing information base, it can provide a comprehensive understanding of a company's strengths, weaknesses, opportunities, and threats.

The financial appraisal provides a quantitative analysis that allows for a well-informed decision. It is essential to identify if the project aims to benefit the business through cost reduction or income generation. The output of the four techniques used for assessing capital projects determines the project's financial viability.

The payback period is a crucial factor to consider.

According to a report by Arnold & Hatzopoulos in 1999, the payback period is used by 70% of companies and it calculates the time needed for a project to recover its initial capital cost. Shorter payback periods are preferred by management because longer repayment times have higher risk and uncertainty. Capital budgeting involves estimating data, with later years' data

being less reliable and riskier for decision-making. Those who are risk adverse prefer to minimize or offset risk, so a quicker payback period is desirable as it reduces project risk.

The payback method, with its ability to assess a project's recoupment of the initial investment within a set timeframe, serves as a valuable tool in investment decision-making. It accomplishes two key objectives: determining whether to accept or reject a project and comparing multiple investments by their payback speed. The preferred choice is the project with the shortest payback time, while the least favored option is the one with the longest payback time. Emphasizing risk rather than being an investment criterion, it should be noted that the payback period primarily indicates risk. This method finds common use in initial screening and evaluating short-term projects.

Advantages

The concept of simplicity

Favors projects that have the potential to generate faster growth for the company and enhance liquidity.

Minimizing risks related to time is the primary focus.

The drawbacks.

This text disregards the concept of the time value of money.

* Disregards cash flows that occur after the payback period is reached.

The main focus is on recovering costs rather than generating profits.

(Williamson, 2003) (Limes Consultancy)

2. The Accounting Rate of Return (ARR) or Return on Capital Employed (ROCE) is a method used to evaluate the profitability of an investment.

The Average Rate of Return (ARR) is utilized in investment appraisal to assess independent or mutually exclusive projects. It represents the average annual net cash flow as a percentage of the original investment. According

to a 1999 report by Arnold ; Hatzopoulos, ARR is used by slightly more than 50% of respondents based on research into a sample of companies from the Times 1000. The advantages of ARR are its simplicity and focus on profitability, but it does not consider the time value of money and relies on the business's chosen depreciation policy. Although this method is profit-based rather than focused on cash flows, its calculations are not overly complicated. It provides the average annual rate of profit earned by an asset or project, which can be compared to other projects or interest rates. In cases where there are multiple mutually exclusive projects, the one with the highest ARR is considered the best alternative. ARR is primarily employed as an initial screening tool or for evaluating small, short-lived projects.

Benefits of Using this Product

The concept of simplicity

Concerned with profitability

Comparability

There are some drawbacks to consider.

Accounting profits are used instead of cash flow as a basis.

This ignores the timings of inflows and outflows.

The text below isand unified while keeping the and their contents.

Ignores the concept of the time value of money.

The depreciation policy adopted by the business determines the outcome.The text inside the paragraph tag indicates three sources: (Williamson, 2003), (Limes Consultancy), and (Business Modules).

The Net Present Value (NPV) method is the third method.

The next two primary appraisal techniques in capital investment are the "discounted cash flows" methods - Net Present Value (NPV) and Internal Rate of Return (IRR). IRR involves comparing the projected rate of return from a project,

calculated using discounted cash flow analysis, with the cost of capital. For an investment to be worthwhile, its IRR must exceed the cost of capital. While this report does not extensively cover IRR as it is rarely used, NPV is more commonly employed according to a 1999 report by Arnold & Hatzopoulos based on research conducted on a sample of companies from the Times 1000.

The NPV investment appraisal method is based on the idea that an investment is worthwhile if the money gained from it equals or exceeds the money invested. This method considers all relevant cash flows related to a project over its lifetime and adjusts future cash flows to their "present value" by discounting them at a rate called the "cost of capital." Therefore, the NPV technique highlights the importance of the time value of money because one unit of currency holds more value today compared to the future. This is because it can be invested and generate returns, even during periods of low positive interest rates. The principle behind this concept is that money loses value over time due to inflation; thus, 100 units today will have less worth in two years. To convert cash flows into present value equivalents, they are multiplied by an appropriate NPV discount rate.

The calculation of the net present value (NPV) of an investment project involves adding the net discounted future cash flows. It is important to remember that money has a time value, meaning that comparing money at different points in time is not simple. To address this issue, the cash flows occurring at different times need to be converted to a

specific point in time. Usually, the present is chosen as the reference point because it has practical advantages. The annual cash flows are discounted and then added together, with the initial capital cost of the project subtracted. The resulting excess or deficit represents the NPV of the project. Having a positive NPV is crucial for a worthwhile project, and a higher NPV indicates greater attractiveness for investment. This approach aligns with the objective of maximizing shareholder wealth.

The discounting methods have several advantages:

Consider the time value of money.

Focused on generating profit.

To establish a consistent baseline for investments with varying lengths, use the current value as the common denominator.

The discounting methods come with disadvantages.

The calculations are more complex in nature.

This text focuses on the selection of a discount rate, which can lead to different solutions. It assumes that any extra cash can be reinvested at the same rate.

A project with a positive or zero NPV should be considered, but if the NPV is negative, there are reasons to reject it.

It will not generate wealth.

The text states that the project incurs a loss compared to an investment in the capital market, which is referred to as an opportunity loss.

The return it generates is less than the return that can be achieved in the capital market for similar risk levels.

The execution of the project would not generate sufficient funds to cover the incurred expenses.

According to critics, NPV may not be effective as it does not consider the size of the capital investment needed to generate

value and may not determine the optimal combination of projects in cases where there is limited capital. These views are expressed in sources such as Business Support micro modules, Limes Consultancy, Williamson (2003), and HNC Business (2000).

4. The net value.

The total net inflows plus the residual value (scrap value) minus the initial capital cost will provide a different answer to the NPV, as it disregards the time value of money.

The assessment of investment appraisal methods is being evaluated.

Different methods of investment appraisal serve distinct purposes, and companies like Mortons Engineering Ltd typically employ a combination of these approaches to evaluate potential investments. A study by Arnold & Hatzopoulos in 1999 examined companies from the Times 1000 and found that respondents did not rely solely on one method for investment appraisal; instead, they utilized a variety of methodologies (Limes Consulting).

Financial analysis encompasses combining various isolated factors to provide a comprehensive overview of financial performance (McKenzie, 1994 p129).

The following section analyzes the outcomes of the investment appraisal methods for the three potential new systems for Mortons Engineering Ltd. These results will be assessed to determine the most suitable system to implement. Alongside the examination of these outcomes, other factors, including the installation timeframe, staff reductions, and product advantages of each system, will also be taken into account. Although there are additional aspects to consider before reaching a final decision, this report solely focuses on the financial perspective.

HNC Business (2000, p201) emphasizes the significance of taking into account various aspects including personnel, legal matters, ethical concerns, regulatory changes, political factors, and

quality implications.

The following text has been rephrased and consolidated, while preserving the and their contents.

System 1

The system with the shortest payback period is the least risky. However, it doesn't take into account cash inflow after the payback period, which actually decreases. It also has higher cash inflows compared to system 3, making it less risky and improving liquidity. Additionally, it has the highest ARR, indicating the best return on investment. The NPV, considering cash inflows in real terms, is also the highest among the three systems and the only positive result. Based on this method, this system is worth considering as it has the shortest installation time and lowest initial outlay.

In comparison to the NPV, the lowest net value is considered insignificant. It also involves the highest staff reduction and produces only three distinct products.

System 2

The system provides six different products, cuts staff by ten people, and has a payback period of just three years. This is only half a year longer than system 1, making it relatively low-risk. Furthermore, it produces high early cash inflows, which enhances liquidity.

However, system 2 has the lowest average accounting rate of return, indicating the lowest return on investment compared to the other two systems. Despite this, the percentage is still relatively high when compared to bank interest rates. System 2 also has the lowest NPV among the three systems, with a negative figure, making it not worth considering according to this method. Additionally, it requires the highest initial outlay and takes twice as long as system 1 to install, requiring six months.