Capital Budgeting and Financial Calculations - Essay Example

Academic Report and Financial Calculations Table of Contents Executive Summary 3 Introduction 3 Workings and Calculations 4 Payback Period 4 Average Rate of Return (ARR) 5 Net Present Value (NPV) 5 Evaluation of Chosen Project 6 In Context of PESTEL Factors 7 In Internal Context 8 Ethical Considerations 8 Evaluation of HR Function Model 9 Conclusion 10 Recommendation 11 Reflective statement 12 Reference list 12 Executive Summary Capital budgeting is the process of evaluating long term investment proposals and making the optimal decisions among them. A brief introduction has been provided regarding the capital budgeting process. Necessary calculations were done for calculating the payback period, net present value and average rate of return of the two projects and recommendations were given regarding the profitable proposal. The implications of the projects and its impact on HR were analysed. Also, ethical considerations of the selected project were analysed using relevant ethics theory. A model of the HR function and its implications were critically evaluated in light of the chosen capital investment project and trading with its Co-share. As per the evaluation of the project suitable conclusions and recommendations were provided and in addition the reflective statements were prepared. Introduction Capital budgeting is a method through which a firm decides to invest in the long term investment proposals (Baker and English, 2011). Capital budgeting can also be measured as a scheduling process which helps in deciding which investment like new machinery, new products, replacement machinery and new plants can prove to be cost effective (Phaup and Kirschner, 2010). It is used for budgeting of vital capital investments. The different techniques for calculation used in the capital budgeting process are NPV method, IRR method, payback period and profitability index method. In the capital budgeting process, there exist some non financial qualitative aspects in case of project viability (Lan, Chung, Chu and Kuo, 2003). Every organization is recognized for their surroundings and norms. It becomes necessary to gauge in order to shape the behavior of the employees in an organization. There are three stages in capital budgeting analysis including decision analysis for building knowledge, option pricing for establishing position and discounted cash flow for making decision regarding investment (Garcia, Contreras, Correia and Muñoz, 2010). In context of project valuation, it is necessary for a company to ensure that their potential projects are in order to the employee’s culture because going further than that may crash the financial factors. The study is conducted to analyze the implications of the project and their impact on human resource (HR) (Law, 2004). The implications of the project includes capital budgeting calculations to choose the profitable project, evaluation of the chosen project, ethical considerations and relating a HR function model with the chosen project. The objective is to evaluate the projects and come to a conclusion and define suitable recommendations in accordance to the chosen project (Pérez, Tarrío and Pasqual, 2005). Implications of Projects and Impact on HR Workings and Calculations Payback Period Figure 1: Payback period calculation for project A Year Net cash flow £ Cumulative cash flows £ 0 -34000 -34000 1 7000 -27000 2 17000 -10000 3 28600 18600 4 30000 48600 Payback period 3.34965035 The payback period is 3years + (10000/28600) = 3.34 years Figure 2: Payback period calculation for project B Year Net cash flow £ Cumulative cash flows £ 0 -34000 -34000 1 14000 -20000 2 21000 1000 3 23000 24000 4 27000 51000 Payback period 3.043478261 The payback period is 3 years + (1000/23000) = 3.04 years Average Rate of Return (ARR) Calculation of average rate of return for project A £ (7000 + 17000 + 28600 + 30000) / 4 = £ 20650 Average rate of return of project A = (£ 20650 / £ 34000)*100% = 60.73% Calculation of average rate of return for project B £ (14000 + 21000 + 23000 + 27000) / 4 = £ 21250 Average rate of return for project B = (£ 21250 / £ 34000)*100% = 62.50% Net Present Value (NPV) Figure 3: NPV calculation of project A Year Net cash flow £ Discount factor 12% Present value of cash flow £ 0 -34000 1 -34000 1 7000 0.89285714 6249.99998 2 17000 0.79719388 13552.29596 3 28600 0.71178025 20356.91515 4 30000 0.63551808 19065.5424 Cumulative cash inflow 25224.75349 Net Present Value (NPV) 59224.75349 Figure 4: NPV calculation for project B Evaluation of Chosen Project Various workings or calculations are carried out for analyzing the projects and to select the most profitable among them. Based on the calculations, it is found that Project B has a greater net present value than project A. Hence, the LCJ Ltd Company is advised to invest on project B as NPV method recommends selecting project having greater NPV (Hsieh, Dye and Ouyang, 2008). Also after going through the calculations of the average rate of return it is justified to go for investing in project B as the average rate of return of project B is comparatively higher than the project A. The ARR method suggests selecting the project with larger ARR value. In addition to that, the calculations of the payback period suggests the investor to invest in the project B rather than investing in project A as the payback period of project B is less than the project A (Garrison, Noreen and Brewer, 2003). Payback method considers selecting project which has lesser Payback period. Lesser payback period means recovering money in lesser amount of time possible. Hence, by considering various calculations it is justified to recommend the investor to invest in project B as it satisfies financial factors that are proved to be beneficial (Marino and Matsusaka, 2005). In addition to the profitable financial factors, project B is also considered beneficial as far as non financial factors are considered. In project B a new computerized quality checking system will be introduced in the company’s warehouse. This will increase in the productivity levels and the introduction of the machine will also reduce the number of warehouse staff (Posner, Ryu and Tkachenko, 2009). Non financial benefits can hence be attained by choosing project B. On the other hand, less staff in the warehouse will be easier to manage hence the human resource management of the organization will become much efficient (Hartman, 2000). In Context of PESTEL Factors Besides considering the financial benefits of implementing project B, the external factors affecting the implementation needs to be monitored. Political factors of implementing the project should be considered (Baker and English, 2011). Implementation of the new machinery and accordingly executing various other changes are as per the political situations of the country and the company will get enough political support to implement such changes. Economical factors can serve to be the determinants whether the economic performance of the company will support the purchase of the new machinery. Economic factors can be measuring the inflation rates, economic growth patterns etc. These factors are necessary for deciding that purchase of the new machinery will prove to be economical in the long run (Fairchild, 2005). Social factors measure the changing perception of the society after the implementation of the project (Fairchild, 2005). The social groups may feel that implementation of new machinery will in turn increase the efficiency of the company but they also may feel that discharging the employees due to introduction of the machinery is unethical. Therefore how a company will be portrayed by the society should be evaluated. Technological factors imply ensuring that there is enough technical support available if the new machinery is introduced in the firm. The employees’ adaptability to the technical changes also needs to be measured. Introduction of the new machinery will prove to be beneficial in the long run or not should also be evaluated before selecting the project. Legal factors takes into account the consumer laws, safety standards and the labour laws are strictly followed by implementing changes in the organization (Baker and English, 2011). In Internal Context Cultural factors needs to be considered while implementing strategies to bring in change. The changes will be accepted by the employees or not depends upon their cultural values possessed by the staff and also on the existing technological and material culture of the organization (Chen, 2008). Social relationship implies whether the implementation of the new machinery and discharge of few employees will affect the relationship of the management and the existing employees or not (Chen, 2008). The employees will take these changes positively and maintain a cordial relationship in the organization or not should be considered. Power and Control of the authorities are enabling employees to adapt to the changes or not should be analysed in order to evaluate if maximum benefits can be derived by implementing project B. Ethical Considerations The investment proposal to be selected is project B after analyzing various financial and non financial factors. The company under project B plans to introduce a new computerized quality checking systems in the warehouse. In traducing the new machinery will in turn reduce the number of warehouse staff; the reduction of employees will be approximately 18%. The company also require high quality produce from their suppliers. The company is also expecting the productivity level to increase by 17%. The conditions prevailing in the company in case of project B, reflects some ethical issues. There was a lack of Utilitarian ethics in the organisation and which would increase if project B is implemented. Utilitarian theory is a normative theory of ethics that focuses on choosing an action or policy over another action (Baker and English, 2011). It moves further than the scope of an individual’s own interest and looks forward to consider the interest of other employees of the organization. According to this theory actions are implemented as per the interests of the employees and their benefits are taken care of. The company decided to downsize thinking about the cost effectiveness and with a belief that the introduction of the computerized system will ease out their work and will produce quality results. The company’s decision of downsizing may go against the ethical values of the company as per the theory (Farragher, Kleiman and Sahu, 2001). Downsizing has many negative implications in perspective of lost benefits and wages for the workers. The thing that is important is the treatment of the employees who are released from the organization and those employees who remain in the company (Marino and Matsusaka, 2005). The company which provides no attention towards the cause of the downsizing can lead to hamper the morale of the remaining employees (Block, 2005). If the company treats the employees poorly, especially those who are leaving the company, then it would create a negative impact on employees both internally and externally. The company hence should consider the negative impacts of downsizing and should provide well treatment to those employees who are released or else a negative opinion of the organization can spread out to the society (Psacharopoulos and Patrinos, 2004). The employees who remain in the organization could become demotivated and their productivity might get degraded. These ethical issues must be addressed by the company and the utilitarian ethics theory needs to be implemented in a proper way in order to run its business successfully and portray a positive image of the organization to the society (Kahraman, 2001). Evaluation of HR Function Model According to the chosen capital investment project, that is project B, the Storey’s strategic model is the most suitable HR model to be implemented (Froot and Stein, 2008). The company under project B requires high level of quality produces from their employees in order to boost up their company shares. In such a situation, the model will best suit to address the company issues. The Storey’s strategic model is proved to be much effective in bringing noteworthy value to the firm. The model if implemented in the company can reduce the operating costs of the firm and gain efficiency by reducing the number of service employees in the firm. Storeys model believes that an HRM can be considered as a set of interrelated policies based on ideological and philosophical foundation. The model describes that the functions of the HR can be plotted against two axis inventory and strategic (Dean, 2000). Their roles involved developing policies and strategies for implementing change by not hampering the interests of the employee. As per this model selection of people should be done matching the requirements of the job and in order to bring in positive changes in the company’s shares. Strategies should be implemented in order to develop high quality employees who can possess the adaptability to the technological changes that will occur after the implementation of project B (Garcia, Contreras, Correia and Muñoz, 2010). The architectural nimbleness of the firm can be enhanced by transforming into new organizational forms like “shared service organization” and “service oriented enterprise” (Dayananda, 2002). The organizational innovation and learning can also get enhanced by focusing on gaining expertise on technical and managerial aspects and facilitating knowledge allocation. The service quality can improve through formation of customer oriented mindset within the service firm and by professionalizing service delivery. Political advantages can also be gained by implementing the model as it might enhance creditability and help in solving internal grievances. (Covaleski, Evans and Shields, 2006). In this era of global economic recession, there is a need to leverage the usefulness of shared services (Verbeeten, 2006). Ample risks that come along with the implementation of the HR model needs to be addressed by the firm in order to gain maximum from the models approach. The risks involved can be like over standardization of systems and procedures, operational flexibility insufficiency, excess complexity of systems, dampened worker buoyancy and unexpectedly implementing cost acceleration (Yard, 2000). These risks generate from today’s volatile economic environments and occurrence of unpredicted events. These risks might affect the share services perceived and real value and hence the models user satisfaction might get reduced. By effectively dealing with the risks, the company can surely benefit from the Storey’s strategic model (Kahraman, Ruan and Tolga, 2002). Conclusion An in-depth study of the capital budgeting method was conducted in order to advice the company to make an effective investment decision among the two projects, project A and project B. In order to advise the company to make an investment, various calculations was done to analyze the financial benefits of both the projects. According to the specified data in the projects, the NPV, ARR and the payback period was calculated. Then the result came out to be in support of project B. It had better NPV, ARR and a lesser payback period than project A. Besides the beneficial financial factors of the project A, there were many non financial factors that also supported the selection of the project B (Froot and Stein, 2008). Then a brief evaluation of the chosen investment proposal was conducted and discussed broadly how the project B is financially profitable to the company. Selection of the project was also based on the PESTEL analysis and various other internal factors such as corporate culture, power and control of the government authorities. Besides the capital budgeting process these factors also needed to be considered for analysing various other environmental effects of implementing project B. In addition, the ethical problems in the company were also considered. The result came out that some ethical issues might arise after implementation of project B. The company hence needs to consider the ethical issues and effectively deal with them. A model of human resource function was also required to evaluate in light of the chosen project B. The Storeys model was found suitable for the investment project. This model is supposed to be beneficial for the company in reducing the operating cost of the firm and also in gaining some political advantages (Farragher Kleiman and Sahu, 2001). In conclusion it can be stated that by considering every financial and non financial factor, the selection of project B is feasible for the company. Recommendation By conducting the detailed study of both the projects among which the company wants to invest in, it is recommended to the company to make in investment in the project B as it is expected to bring out profitable results to the company. Also by evaluating the selected project B, a recommendation can be made to also consider the non financial factors associated with the project along with the financial factors (Durnev, Morck and Yeung, 2000). Along with the financial factors the internal and external environmental factors should be kept in mind which can affect the performance of the implemented project. The non financial factors can equally be useful in deciding the cost effectiveness of the project implementation. By determining the ethical issues that might arise in the company after implementing project B, it is recommended to initiate steps or implement various strategies in addressing the supposed ethical worries. If the ethical issues are not addressed, it might result in degradation of the existing employees’ morale and they can turn out to be less productive (Dean, 2000). The Storeys model of human resource is analyzed to enhance the human resource benefits along with the financial benefits of the project B. Hence, it is strongly recommended that the model should be implemented by the management of the organization which will in turn help the company to manage workforce well, enhance the service quality and boost up company shares (Marais and Saleh, 2009). Reflective statement I consider the strengths of this work to be the efficient use of capital budgeting process in making the investment decision. NPV, ARR and payback period calculations are very effective in deciding the risks and rewards of the proposals. Decision based on this method gives accurate results and hence the outcome after implementing project B will prove to be gainful for the company. I consider the weaknesses of this piece of work to be the ethical issues that are perceived to occur after implementing the project B. The downsizing can create a negative impression on employees and society towards the organization. Some solution needs to be found out for solving ethical issues and for the implementation of the proposal to be fruitful. I think I could improve this piece of work by considering the sensitivity analysis such as the downturn of today’s economy can change the inflation rates which in turn can change the discount rate. The calculation of NPV will hence give out different results. Sensitivity analysis hence could have helped in improving the decision making process to select the best proposal for the company. I would like the assessors to comment specifically some of the aspects of this piece of work like how effectively the capital budgeting method and calculations was done in selecting the right investment proposal. I would like the assessors to comment on the HR model used to complement the selected project and its relevance in addressing the firm’s issues. Reference list Arsiraphongphisit, O., Kester, G. W. and Skully, M. T., 2000. Financial Policies and Practices of Listed Firms in Thailand: Capital Structure, Capital Budgeting, Cost of Capital, and Dividends. Journal of Business Administration, 8(4), pp. 72-93. Baker, H. K. and English, P., 2011. Capital budgeting: an overview. Capital Budgeting Valuation: Financial Analysis for Todays Investment Projects, 2(1), pp. 1-16. Block, S., 2005. 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