Various companies use the net present value (NPV) as one of the capital budgeting methods in their efforts to determine whether a venture is worthy of its investment. The company in question considered NPV because of its numerous benefits. One of these benefits is that NPV considers the time value of money (Almaktar, Rahman & Hassan, 2016). It mentions that a shilling today is more valuable than a shilling tomorrow or in the future. Moreover, NPV takes into consideration the entire cash inflow from the time the business commences to the time of closure of operations (Almaktar, Rahman & Hassan, 2016). The last benefit of this capital budgeting method is that it is the most precise method in predicting the sustainability of any particular venture.
Based on the NPV calculations indicated in the excel templates, I would recommend the organization to pursue project C. This is because project C yields a positive NPV. Project C generates an NPV of 17,011 and 15,298 with the application of 5.5% and a 6% discount rate, respectively. Therefore, project C increases the shareholders’ wealth as it maximizes their investment. Projects A and B yield a negative NPV, and as such, they would decrease the shareholders’ wealth. The shareholders may incur losses if the management undertakes either project A or B.
Conversely, the change in discount rates caused a tremendous difference in the original assessment. For instance, the evolution of the discount rate from 5.5% to 8% in project A caused a decrease in the number of losses to be incurred by the investors. The losses incurred by investors decreased from 9,275 to 6,451. The investors would lose less money when working with a higher discount rate as compared to working with a small discount rate. In project B, a change in the discount rate from 5.5% to 4% spearheaded an increase in the amount of losses to be incurred by the shareholders. The losses increased from a possible 6,021 to 8,886. Finally, in project C, a change in the discount rate from 5.5% to 6% saw a reduction in the amount of profit earned by the shareholders of the company. The benefit reduced from 17,011 to 15,298.
Nevertheless, the change in discount rates also affected the return on investment to be accrued by the firm. However, the difference was consistent since the return on investment indicated an inclining trend for three years. Initially, the trend was -50%, -46%, -43%, and -42% during the entire four years while on utilizing a discount rate of 85, the return on investment inclines at the rate of -50%, -47%, -46%, and -45% respectively. However, project B depicts an inconsistent trend, which is -33%, -38%, -37%, and -36%. Nonetheless, project C depicts a gradual rise in the returns realized by the investment in both instances. The gradual rise in ROI can be attributed to the company accruing a higher income than the costs incurred. A higher can only be attained if the management is dedicated to a central goal and ensures that it is constantly improving in its daily operations.
Based on the payback period, I would recommend that the firm invests in project A. Project A has a payback period of just one year as compared to projects B and C; they have a payback period of 2 years, five months, and two years 11 months respectively. The organization should invest in project A since it takes a short period to recover the initial investment. However, the payback period cannot be used alone to determine which project to invest in when the firm is faced with various choices (Hopkinson, 2017).
Weighted Scoring Analysis
The firm should consider investing in project A. This is because Project A has a weighted project score of about 1. Project A has a weighted project score of 0.775. Therefore, project A is more viable since the amount invested in this project is more likely to yield profits. An investor becomes assured of his investment when the firm undertakes project A. However, project B and C are not viable enough since their weighted project score is slightly far from 1. Project B and C have weighted scores of 0.75 and 0.714, respectively.
Conversely, the change in weightings does not change the weighted scores of these three projects. They remain the same regardless of the change that has been effected in the figures of the weightings. The consistency in the weighted scores indicates that the three projects are viable and are more likely to succeed in the market environment (Hopkinson, 2017).
References
Almaktar, M., Abdul Rahman, H., & Hassan, M. Y. (2016). Economic Analysis Using Net Present Value and Payback Period: Case Study of a 9kWp Grid-Connected PV System at UTM, Johor Bahru Campus. In Applied Mechanics and Materials (Vol. 818, pp. 119-123). Trans Tech Publications.
Hopkinson, M. (2017). Net Present value and risk modeling for projects. Routledge.
