The research investigates a business case and analyzes literature sources on investment decisions, business valuation, capital budgeting, and management accounting. The author aims at presenting and applying a quantitative research approach for capital investment appraisal. The study objective is to evaluate and recommend the company the most beneficial investment. Hence, the author incorporates and applies financial techniques and instruments that enable him to make proper decisions. Moreover, the researcher seeks to get information whether a new investment can be beneficial to the company or not.
The research analyzes the Company XYZ that is going to expand the organizational capacity, development, and growth through the purchase of a new printing machine. There is a belief that this acquisition can add value to the organization. The author shows that the capital investment valuation is a standard and commonly accepted process. Therefore, it is essential to refer to the new printing machine as alternative substitutions of the old one. However, financial managers should follow a certain methodological approach and carry out a different calculation to evaluate the machine as an independent project. Afterwards, there is a need to indicate the outcomes.
The paper determines the evaluation values for each machine with the help of the discount rate calculation, the terminal cash flow calculation, the calculation of incremental operating cash flows, and the initial investment cash flow calculation. Hence, the researcher calculates and presents the relevant costs and revenues to raise an incremental organizational change. It is necessary to perform different incremental cash flows to assess the project value. The general manager has suggested replacing the old printing machine with a new one and proposed to select among two ones. Incremental cash flows will assist in evaluating this proposal. Hence, it is essential to take into consideration that cash flows are related to the current and future costs, past spending is irrelevant, cash flows should be carried out for all three machines (old press, press A, press B), and the application of the MACRS 5-year schedule. Moreover, there is a need to compare the old machine with the suggested options, make calculations in USD, and not consider inflation to get the result succession. Thus, the researcher has analyzed the cash flows on the application for the following machines: Terminal Cash Flows, Initial Investment Cash Flows, and Incremental Operating Cash Inflows.
The related depreciation calculations and the machine taxes are required to make the calculation of initial investment cash flows. Therefore, the author provides the needed data that indicate the price of machines. Moreover, he describes the calculation of the Incremental Operating Cash Inflows, presenting the operating inflows for every machine. The terminal cash flow calculation is discussed with the emphasis on the discount rate calculation and the summary of the relevant cash flows.
The researcher has applied the techniques of capital budgeting, including the internal rate of return (IRR), the net present value (NPV), and the payback period (PB). Besides, he has examined the importance of these methods under the organizational capital rationing. First, the paper provides the analysis of relevant literature that demonstrates the measurement conducted through the most common techniques. It has been found that the PB technique is used to calculate the required project period to recover the initial investment using cash flows. The NPV is referred to as a discounted cash flow which applies the capital cost to determine the present stream value of future cash flows. In other words, it is the difference between the investment amount and the present value of future investment cash flows (Wu, 2010). It is possible to calculate the present value of expected cash flows by discouning them. The author states that IRR and NPV are applied to conduct a comparative evaluation despite the following fact. The PB is considered to be an indicative investment evaluation index. Hence, IRR is described as the technique of a discounted cash flow, while IRR is defined as the average annual return received through the investment life. The article provides the IRR calculation for discussed machines.
Further, the article represents the result comparison and summarizes the conducted calculations. There is a claim that capital rationing indicates the idea that the company has not enough capital available that can be used to support all projects suggested within the organization. It is emphasized that the general manager spoke about the need to select only one machine. The author states that this project is non-divisible and should be evaluated. Its evaluation through the use of capital rationing enables to find out the greatest benefits available to the company with the existing capital. It can be done without a specific ratio that aims at comparing the present expected cash inflow value with the given investment amount. This process is referred to as a profitability index.
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Moreover, the paper shows the incorporation of the risk parameter in the calculations. The author claims that is it essential to take into account the factor of uncertainty as risk tends to affect the process of investment evaluation. The activity may result in a change of final decisions. In the case of capital budgeting, it is essential to present and measure the risk factor. The analysis has shown that uncertainty leads to the delay of the investment commitment. It is related to the consequence associated with the investment decision time coordination and the threshold existence. Hence, irreversibility results from uncertainty that is relevant to the future cash inflows as the invested amount is known. One is the common methods used to mitigate the risk and investigate possible investment outcomes is known as a scenario analysis (Ergen, 2012). A decision tree diagram is applied to determine an optimum action course in case of uncertain outcome alternatives. The paper provides the diagram that presents the particular decision, interplay, and interrelationships between different decisions, alternatives, and potential results. However, the literature analysis has shown that such decision trees are not useful if the company has several possible decisions. Moreover, the presence of multiple uncertainty factors results in the increase of the tree complexity. The Risk Adjusted Discount Rate (RADR) is analyzed as the rate being used to provide an investor with the compensation for the risk taken. As a rule, the increased risk results in high the RADR. This rate is subjective and difficult to specify.
The author discusses two main ways in which the organization can finance its investment. The identification of the best financing mix is presented through the analysis of the relevant literature. The article suggests two primary channels that enable to raise capital and carry out the investment financing. One of them is equity financing that is used to issue bonds and stocks or sell stocks, get reach of venture capitalists through the existing capital of the company, as well as retain profits and re-invest them. Debt financing is implelmented to lease, get a bank loan, and get the governmental funding loan.
Moreover, the paper presents and discusses the concept of capital structure and analyzed the means that may be used by the organization to alter its capital structure in terms of the value impact. It has been found that the capital structure is defined as the study that deals with financing sources that are used by many companies to finance real investments. As a rule, it is related to the organization’s debt-equity mix and the decisions related to this aspect in terms of balance maintenance. The analyysis of relevant literature has shown there are arguments related to the link between diversification and capital structure. There is a claim that the company has always an option to use a part of its equity income to redeem debt and rebalance this ratio. Moreover, the structure of the optimal capital leads to maximization of organizational values. The research indicates that the capital structure is closely related to the company’s value. In case the organization takes a decision to change its capital structure, it reveals the necessary information to shareholders concerning the opportunities to the potential investment. In addition, any potential rise of the capital, initiated by either outside or inside, may directly influence the financial position of stakeholders.
Finally, the paper explains whether the firm should undertake the discussed investment. The effect calculation is carried out through the use of the Dividend Discount Model. The author states that dividends indicate the future cash flows and present some information about the company. The Dividend Discount Model (DDM) enables to perform the company’s share valuation (Slavec & Prodan, 2012). The author suggests making certain considerations that should not be related to the given forecasts. These assumptions include the discount of the terminal value, the discount of each dividend on the annual basis, the assignment of the year 6, the definition of the year 5 as the terminal year T, and others. The DDM is referred to as a procedure that helps to value the stock price through the use of forecast dividends and discounting them to the present value. The high DDM value results in the undervalued stock. The author represents the table that makes it easy to understand that the investment may raise the company’s value.
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The researcher concludes the paper with a final recommendation and a rationale, demonstrating certain ideas and findings received from the literature analysis. He makes an attempt to analyze the capital structure change, its influence on the company, and associated risks (Ergen, 2012). The research results indicate that there is much literature related to the problem under investigation. They deal with the separation and different method between the organization’s management and investors. It is essential to note that the core aspect of the corporate governance is to make sure that shareholders get their investment return. The author examines that case study that is relevant to corporate governance and corporate finance. Therefore, he has developed the methodology to identify and investigate a new opportunity for the analyzed company, presenting solid arguments.
The received data have shown that the purchase of press machine B is a preferable project that requires different techniques ensuring the forecast validity. Moreover, the author has taken into account capital rationing and risk. However, some attempts have been made to cover the concept of capital structure and raising the alternative instruments. Such ones associated with the firm’s finance that enable to finance the project. It has been concluded that equity financing and debts have both benefits and drawbacks. The analysis indicates that the company should take into consideration equity financing. It is recommended to the general management to discuss with shareholders the project financing possibility and cooperate any further investment possibilities. The study indicates that the dividend policy will positively influence shareholders. Hence, managerial finance maximizes the shareholders’ wealth and implies the discounted earning value, as well as the significance of understanding the time value of money. It implies the costs and benefits over time. Therefore, risk and time are referred to as two important valuation investment aspects. Thus, the research has presented a proposal and support of academic views and arguments.