Capital Investment Decisions Case Study and Presentation Summary

Capital Investment Decisions Case Study and Presentation Summary

Introduction

Capital investment decisions are very important in growing any business. When making any capital investment decision one must consider the net present value and the internal rate of return. The net present value is the difference between the present value of cash inflows and the present value of cash outflows. Therefore, the person doing the calculations should have an understanding of the cash inflows of the company. However, the internal rate of return is used to used to make the net present value of all cash flows from a project equal zero. In this paper, we will summarize the Making Norwich Tool's Lathe Investment Decision Case in Chapter 9 of Principles of Managerial Finance.

Summary A

The payback period is commonly used to evaluate proposed investments. (Principles of Managerial Finance) 2006. A payback period is the amount of time required for the company to recover its initial investment within a project and is calculated using cash inflows. The calculation for the payback period is considered an unsophisticated calculation. When evaluating the decision criteria for a payback period, accept the project only if the payback period is less than the maximum acceptable payback period, as shown in question A.

Summary B

As for question B, this shows that the payback periods can be viewed as a risk exposure measure. Per the excel spreadsheet the risk exposure is lower due to the higher investment. The excel spreadsheet also shows that Lathe A has a lower internal rate of return (IRR) of 15.95% with a Net Present Value or (NPV) of $58,133. Lathe B has a Net Present Value (NPV) of $43, 483 and an Internal Rate of Return (IRR) of 17.34%. This calculation is considered a sophisticated budgeting technique. There are three major weaknesses when using the payback period to evaluate risk exposure. First, the payback period is a subjective number which can be modified by individual bias. Also, the payback period is not based on discounting cash flows to determine if they add to the company's value. Second, the payback period is not consistent with the time value of money. Third, the payback periods does not recognize the cash flows that occur after the payback period.

Summary C

The NPV shows the difference between a project's present value and its cost. Naturally a positive value is best for companies and shareholders alike. According to Gitman (2006), NPV is the better approach to capital budgeting as a result of several factors. Therefore, the results on items C, suggest the Net Present Value method is superior for making recommendation. NPV for Lathe A is $58,132; NPV for Lather B is $ 42,483 respectively. Based on this finding both Lathes are