The net present value (NPV) of the proposed investment in ‘HD iCam’ is £160,456.15 at the discount rate of 12%. The NPV is positive therefore the proposed investment is financially acceptable as proven in figure 1 (Megginson, Smart and Lucey, 2008, p268). The NPV indicates that the investment is profitable and if accepted the shareholder wealth will increase (Mackevi?ius and Tomaševi?, 2010).
Figure 1
Illustrated the relationship between the NPV and IRR of an investment
The internal rate of return (IRR) of the proposed investment in ‘HD iCam’ is 17.37%. According to Seal et al. (2015) if the IRR is greater than the discount rate the investment should be accepted. The IRR is higher than the discount rate used by Amaryllo Ltd so the proposed investment is financially acceptable. Figure 1 illustrates if the company’s hurdle rate is lower than the IRR the proposed investment is accepted (Megginson, Smart and Lucey, 2008, p268). The company’s hurdle rate is not provided so assuming the company’s hurdle rate is above 17.37% this proposed investment should be rejected but if the hurdle rate is below 17.37% this proposed investment should be accepted (Gallagher and Andrew, 2007).
The NPV is expressed in terms of currency whereas IRR is expressed as a percentage. NPV and IRR include all project cash flows and recognises the time value of money (Seal et al, 2015). NPV takes into account additional shareholder’s wealth when calculating the profitability of the investment but IRR does not. The NPV method assumes that cash flows are reinvested at the project’s discount rate, whereas the IRR method assumes that the cash flows are reinvested at the project’s IRR. NPV can be used to evaluate investments where there are changes in cash flow but the IRR method cannot. The NPV method produces different results but the IRR always gives the same result for the same project if the discount rate changes. IRR is preferred in individual investments in comparison NPV is preferred in mutually exclusive investments (Bosri, 2016).
As confirmed by Drury (2015), all investments projects cannot entirely be described in terms of monetary costs and benefits, non-monetary aspects are also relevant and should not be considered as less important.
The numerical analysis is important in order to estimate the costs and benefits involved in a particular project. The most feasible investment project is evaluated using the quantitative investment appraisal techniques (Drury, 2015). They provide a comparison between projects and help make decisions on which project to accept. The decision rule for of these techniques are easy to understand and the techniques are simple to calculate. The techniques provide a comparison between projects and help make decisions on which project to accept. Lastly, the techniques will identify the degree of risk associated with different projects, for example, the project with a high ARR is considered more successful than a project with a low ARR (Drury, 2015).
However, the qualitative factors might lead to a decision which contradicts the results of the investment appraisal techniques. All stakeholders should be considered equally, not only shareholders but also employees, the community, customers and environment for a successful investment appraisal (Bamber and Parry, 2014).
The effect of an investment on the employees should be taken into account (Götze, Northcott and Schuster, 2008). The existing employees will operate in the manufacturing of ‘HD iCam’. Hence, employees will need to be trained, training is expensive and may not be effective and delay production. They may also become stressed and demotivated due to a heavy workload, customers will notice these unhappy employees.
The customer satisfaction, product quality, corporate image and objective are important qualitative factors to consider when deciding whether to accept the proposed investment (Götze, Northcott and Schuster, 2008). Amaryllo Ltd has spare capacity in its existing factory and the purchase of this new machine is likely to increase capacity. Higher capacity utilisation can reduce unit costs, satisfying the customer’s needs. Very high capacity utilisation will increase the demand for ‘HD iCam’, to meet this demand less time may be spent on quality control. This can damage Amaryllo Ltd reputation resulting in unsatisfied customers and a decrease in sales.
The impact on the environment should also be considered (Götze, Northcott and Schuster, 2008). Lamb, Hair and McDaniel (2011, p. 6) state that ’50-75% of consumers reported that environmental issues are important’. The new machine should manage waste and energy efficiency for example when it is not required it should be switched off. Ultimately, the final decision should take into consideration the qualitative factors for a successful project appraisal.
The three most common pricing approaches that companies employ include cost-based pricing, competition-based pricing and customer-based pricing.
There are various approaches used under cost-based pricing. In cost-plus pricing, the selling price of a product is determined by adding a percentage markup to its cost. In absorption cost pricing the selling price is determined by accumulating the costs of manufacturing a product this includes direct materials, direct labour and both variable and fixed overhead costs. Whereas, in marginal cost pricing it involves the direct materials, direct labour and variable overhead costs of producing a product (Singh, 2013).
In a competition-based pricing approach, companies are known as price takers, they set a price based on competitors thus a price that will attract customers away from the competition (Pride, Hughes and Kapoor, 2010). This approach is important for companies that have many substitutes for the product and when there are many companies that sell similar products (Verma, 2011).
Demand-based pricing is an approach considering customer’s perceived value of the product so companies set a price based on customer demand (Ramaswamy and Namakumari, 2013). Price elasticity of demand measures the percentage change in quantity demanded caused by a percentage change in price, illustrated in figure 2 (Seal et al, 2015, p653). Demand is inelastic if the value of elasticity is less than one but demand is elastic if the value of elasticity is greater than one. When price elasticity of demand is inelastic if price increases revenue increases and if price decreases revenue decreases. Conversely, when price elasticity of demand is elastic, if price increases revenue decreases and if price decreases revenue increases (Ramaswamy and Namakumari, 2013). Profit-maximising price can be determined by adding the variable cost per unit and markup on variable cost calculated using the price elasticity of demand, shown in figure 3 (Seal et al, 2015, p653).
Figure 2
Price elasticity of demand equation
Figure 3
Profit-maximising price equation
Competition-based pricing is not a suitable approach since the purchase of a new machine will create a competitive advantage. Amaryllo Ltd may receive higher profits even if they have priced higher than its competitors. Cost-based pricing will not be a suitable approach since it is based on assumptions, this is not accurate. These approaches do not consider what customers are prepared to pay.
The most suitable pricing approach that Amaryllo Ltd should select is demand-based pricing as the customer is the foundation of a successful business. Amaryllo Ltd could go out of business because of unsatisfied customers. Customers satisfied with the price will improve customer satisfaction, loyalty and become profitable.
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