Business Decision Making

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Contents
Introduction......................................................................................................................................3

01. Calculation of Payback Period...................................................................................................4

Project A......................................................................................................................................4

Project B......................................................................................................................................5

02. Calculation of NPV....................................................................................................................6

Project A......................................................................................................................................6

Project B......................................................................................................................................6

03. Analysis and discussion.............................................................................................................7

Payback period.............................................................................................................................7

Net Present value.........................................................................................................................8

Financial and non-financial factors.............................................................................................8

Conclusion.....................................................................................................................................11

References......................................................................................................................................12

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Introduction
In investing and capital budgeting methods there are two basic policies. Capital budgeting is the
activity of taking decisions by investing capital through different alternative projects. This report
will show how the NPV is calculated for different projects and what factors could be considered
as selecting projects. The payback period plays a role in project evaluation very easily and
quickly. The shorter the payback period of a project, the more efficient the project and the better
the liquid position of the organization. It will also discuss the payback period and the analysis of
both parts.

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01. Calculation of Payback Period
Project A
Initial investment = 108000

Time = 5 years

So, the data table is

Years Cash flow Cumulative

1 37000
37000
2 42000
79000
3(A) 58000
100000(C)
4 89000(D)
147000
5 105000
194000

Payback Period = A+ ((CF0 – C) / D)

=3+ ((108000-100000)/89000)

=3.09 years

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Project B
Initial investment = 110000

Time = 5 years

So, the data table is

Years Cash flow Cumulative

1 35000 35000
2 38000 73000
3(A) 65000 103000(C)
4 93000(D) 158000
5 110000 203000

Payback Period = A+ ((CF0 – C) / D)

=3+ ((110000-103000)/93000)

=3.07 years

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02. Calculation of NPV
The method by which the difference between investment and current value is calculated by
deducting cash flow at a fixed rate is called net current value (Irwanto, 2022). This method is the
most popular, acceptable and practical strategy of capital budgeting.

Project A
NPV = -C₀ + C₁ / (1 + r) + C₂ / (1 + r) ² + C₃ / (1 + r) ³ + ... + Cn / (1 + r) ⁿ

=(-108000)+37000/(1+0.08)+42000/
(1+0.08)^2+58000+(1+0.08)^3+89000+(1+0.08)^4+105000+(1+0.08)^5

= 214272

Project B
NPV = -C₀ + C₁ / (1 + r) + C₂ / (1 + r) ² + C₃ / (1 + r) ³ + ... + Cn / (1 + r) ⁿ

=(-110000)+35000/(1+0.08)+38000/
(1+0.08)^2+65000+(1+0.08)^3+93000+(1+0.08)^4+110000+(1+0.08)^5

= 222990

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03. Analysis and discussion
Payback period
Any organization invests in various projects for the purpose of making a profit. The time
required to recover this invested money is called the payback period. It helps to measure the risk
in the light of a specific time (Puwanenthiren, 2022). It shows how much time is required to
withdraw the initial invested money. Since there is no complex calculation, it is possible to
easily determine the payback period. It only focuses on the time when the invested money comes
up so investment-related decisions can be taken easily (Sergi, Sari and Senapati, 2022). The
payback period is only interested in those cash flows which are able to bring up the investment.

Since this method only deals with who is investing in return time, it is very easy to get an idea
about it and it can be calculated. The payback period plays a role in project evaluation very
easily and quickly (Drake, Fabozzi and Fabozzi, 2022). The shorter the payback period of a
project, the more efficient the project and the better the liquid position of the organization
Therefore, it is possible to know which project is less risky through the payback period.

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Net Present value
NPV is used to evaluate exactly how much profit a particular investment can make. The NPV
shows that the money earned in the future under this rule is not equal to today's money because
money loses its purchasing power over time due to inflation (Afzal et al., 2022). The current
value of the future cash flow of an investment is determined by the initial cost of investment
through NPV. The discount rate of the NPV formula allows the future cash flow to be discounted
at the current time value (Alles et al., 2021). In this case, if the initial cost of the investment is
deducted from the sum of the current cash flows and the result is positive, then the investment
position can be expected to be profitable (Sergi, Sari and Senapati, 2022).

It is widely used in capital budgeting. The advantages of this method are discussed below:

1. In this method the time value of money is taken into consideration. At a certain rate (usually
the capital expenditure of the organization) the current value is brought by breaking down all the
cash flow of the project (Sergi, Sari and Senapati, 2022). This makes it possible to review the
project properly.

2. This method considers all cash flows for the duration of the project As a result, there is no
possibility of excluding profitable projects (Hasan, Chishty and Burney, 2021). As a result, it is
possible to evaluate the project properly.

3. This method also takes into account the cash flow that occurs in the organization as a result of
the project's debris value. Moreover, the working capital required for the life of the project is also
considered in this method.

As the payback period of project B is lower than the other project it could be a profitable
project.so, project B is a good decision to invest (Bakri, Fifield and Power, 2021). As both
projects have a positive value in NPV, so the higher NPV will be a good decision to make an
investment. Project B has a higher value of NPV.

Financial and non-financial factors

Financial factors

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Influence on liquidity position and financial decision-making: The liquidity position of an
organization influences the financial decisions of that organization. Dividends are usually paid in
cash, indicating a good liquidity position of the organization. Companies adopt a liberal dividend
policy if their working capital is too large (Bakri, Fifield and Power, 2021). In this case,
companies must follow a conservative dividend policy. Indeed liquidity changes the nature of the
organization's financing and dividend decision-making.

External factors influence financial decision-making: In addition to internal issues, there are
many external factors that influence financial decision-making in companies. These decisions are
related to the long term assets of the organization. So it can be said that the more accurate the
external decisions of the organization, the stronger the business position will be in the long run.
External decisions affect the future prospects of the business. External factors include the state of
the economy, the structure of capital and money markets, government regulations and tax policy.

Non-financial factors

Institutions want to produce quality products but often fail to produce quality products. Whether
the quality of the product is low for any reason or not, some non-financial results can be noticed.
(Failure to achieve Customer Satisfaction): It is not possible to achieve customer satisfaction if
the product is not delivered, which has a negative impact on the organization. In case of any loss
to the buyer due to the purchase of substandard goods, the manufacturing company has to bear
its responsibility.

To Increase Cost: There are various costs to be incurred due to product malaise including
preventive cost, valuation cost, extreme deviation cost, external deviation cost.Losing Market
Share: The market share of a particular product or service is the market share of the organization.
Buyers are likely to call everyone who looks appropriate, if there are only a few.

Failure to Achieve Certificate of Standard. This certification implies that the company produces
quality products (Bakri, Fifield and Power, 2021). Therefore, if for some reason the company

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fails to produce quality products, the organization may fail to get the standard certificate and the
government may also cancel the standard certificate.

Losing Customer: When the company repeatedly produces Nishman products, the buyers refrain
from purchasing the products of that company, as a result of which the company producing
Nishman products loses the buyer.

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Conclusion
In light of the above discussion, capital-budgeting is a long-term investment decision-making
process in which the potential to make a profit by estimating income-expenditure on purchasing,
replacing, expanding, or modernizing the organization's fixed assets, such as land deposits,
buildings, machinery, furniture, etc. Decisions are made by analysis. That is to say, new
investment decisions or purchases of property, restoration or change of existing property, and
expansion or modernization of property are the three areas of capital budgeting. This report has
successfully shown how the payback period and NPV find out the best alternative and make an
investment decision.

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References
Afzal, F., Shehzad, A., Rehman, H.M., Afzal, F. and Mukit, M.M.H.M.H., 2022. Risk perception
and cost of capital in emerging market projects using dynamic conditional correlation
model. International Journal of Islamic and Middle Eastern Finance and Management.

Alles, L., Jayathilaka, R., Kumari, N., Malalathunga, T., Obeyesekera, H. and Sharmila, S.,
2021. An investigation of the usage of capital budgeting techniques by small and medium
enterprises. Quality & Quantity, 55(3), pp.993-1006.

Bakri, A., Fifield, S.G. and Power, D.M., 2021. Capital budgeting practices and political risk:
evidence from Lebanon. Qualitative Research in Financial Markets.

Drake, P.P., Fabozzi, F.J. and Fabozzi, F.A., 2022. Capital Budgeting: Estimating Cash
Flows. World Scientific Book Chapters, pp.313-343.

Ersen, H.Y., Tas, O. and Ugurlu, U., 2022. Solar Energy Investment Valuation With
Intuitionistic Fuzzy Trinomial Lattice Real Option Model. IEEE Transactions on Engineering
Management.

Hasan, S.S., Chishty, B.A. and Burney, A.I., 2021. An empirical insight into the Capital
Budgeting Practices in the Manufacturing Firms in Pakistan. KASBIT Business Journal, 14(4),
pp.231-247.

Irwanto, R., 2022, January. Why IRR is not the right measure for return analysis and What’s
then?. In International Conference on Engineering, Construction, Renewable Energy, and
Advanced Materials.

Puwanenthiren, P., 2022. National development level effects on capital budgeting practices: a
comparative study of nature vs nurture. PSU Research Review.

Sergi, D., Sari, I.U. and Senapati, T., 2022. Extension of capital budgeting techniques using
interval-valued Fermatean fuzzy sets. Journal of Intelligent & Fuzzy Systems, (Preprint), pp.1-12.

Sergi, D., Sari, I.U. and Senapati, T., 2022. Extension of capital budgeting techniques using
interval-valued Fermatean fuzzy sets. Journal of Intelligent & Fuzzy Systems, (Preprint), pp.1-12.

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Sureka, R., Kumar, S., Colombage, S. and Abedin, M.Z., 2021. Five decades of research on
capital budgeting–A systematic review and future research agenda. Research in International
Business and Finance, p.101609.

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