BUS 5110 - AY2020-T4 -Written Assignment Unit 6 1

Manufacturing Company Case study

Management accounting bring a lot to decision making in order to secure the business
profitability on short and long term. Seize the opportunity to increase the company cash flow
require to use financial data on accrual basis and to make right investment decision for the
company on a long-term run is called Capital budgeting decision. Return on investment and
increase in future of the cash company has today drives the evaluations performed with the
different methods and calculation of this process. We will in this paper as financial department of
the Manufacturing Company evaluate based on calculations and recommend the best decision
option of equipment acquisition investment.
Capital budgeting decisions involve using company funds (capital) to invest in long-term assets
(Heisinger & Hoyle, 2012). In other word Manufacturing Company must decide for which
option to invest for equipment. Based on inputs received we will calculate NPV, IRR, Payback
Period, and ARR for each option after preparing the Total Cash flows in/out, Present Value for
each year. The formula of Present value is Future value multiplied by Present value factor.
Option 1

Figure 1: Net total Cash flow and Present Value for the life of Equipment investment option 1

Timeline n -> Today Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Equipment value (65,000)
Maintenance Cost (2,700) (2,700) (2,700) (2,700) (2,700) (2,781) (2,781)
Material Cost (15,000) (10,000) (10,000) (10,000) (10,000) (10,000) (10,000)
Labor Cost (70,000) (72,100) (74,263) (76,491) (78,786) (81,149) (83,584)
Revenue Cost 75,000 100,000 125,000 150,000 150,000 150,000
Total Cash In/Out (65,000) (87,700) (9,800) 13,037 35,809 58,514 56,070 53,635
Present value Factor 1 0.925 0.857 0.793 0.735 0.680 0.630 0.583
Present Value (65,000) (81,123) (8,399) 10,338 26,320 39,790 35,324 31,269
Note: The amounts show in bracket is negative one and without bracket is positive one

As stated by Heisinger and Hoyle (2012), The net present value (NPV) method of evaluating
investments adds the present value of all cash inflows and subtracts the present value of all cash
BUS 5110 - AY2020-T4 -Written Assignment Unit 6 2

outflows. NPV of option 1 for Manufacturing Company is equal to $(11,483) mean negative rate
of return on investment.
Let find now the IRR, Investment Rate of Return, the rate for NPV equal to zero. We computed it
in Excel using the Fx =IRR(Total cash column rang,0.08) giving result 6%. We can also do it
manually as NPV is negative by decreasing the Company net expected rate of return from 8% to
7% then 6% till we find NPV value closest to 0. Again, we have a negative indicator to proceed
with the investment as 6% is less than expected Company rate of return which is 8%.
Pay back estimation show how fast we will get our cash back. Year 0 unrecovered investment is
$(65,000), Year 1 one is Sum of Year 0 and Year1 $(152,700), Year 2 Sum gives $(162,500), Year
3 $(149,463), Year 4 $(113,654), Year 5 $(55,140), Year 6 gives a positive value of payback
$930, and initial Investment return can be seen at Year 7 $54,566. We can conclude that payback
is more than 6 years.
Last one is ARR, Accounting Rate of Return estimate annual return of an investment, compare to
initial investment, the lifetime of the investment. It doesn’t need cash flow or time value of
money. By dividing yearly, the Revenue by initial investment we have an average ratio of 10%
Option 2

Figure 2: Net total Cash flow and Present Value for the life of Equipment investment option 2

Timeline n -> Today Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Equipment value (85,000) 13,000
Maintenance Cost (3,500) (3,500) (3,500) (3,500) (3,500) (3,605) (3,605)
Material Cost (20,000) (15,000) (15,000) (15,000) (15,000) (15,000) (15,000)
Labor Cost (60,000) (61,800) (63,654) (65,564) (67,531) (69,556) (71,643)
Revenue Cost 80,000 95,000 130,000 140,000 150,000 160,000
Total Cash In/Out (85,000) (83,500) (300) 12,846 45,936 53,969 61,839 82,752
Present value Factor 1 0.925 0.857 0.793 0.735 0.680 0.630 0.583
Present Value (85,000) (77,238) (257) 10,187 33,763 36,699 38,958 48,244
Note: The amounts show in bracket is negative one and without bracket is positive one

NPV= addition of PV’s, Inflow minus outflows gives $5,375, which shows a positive return on
Investment, IRR Computed =IRR(Total cash column rang,0.08) gives 9% more than company
expected rate of return.
BUS 5110 - AY2020-T4 -Written Assignment Unit 6 3

Payback gives Year 0 unrecovered investment is $(85,000), Year 1 one equal to Sum of Year 0
and Year1 $(168,500), Year 2 Sum gives $(168,800), Year 3 $(155,954), Year 4 $(110,018), Year
5 $(56,048), Year 6 gives a positive value of payback $5,790, Year 7 a value of $$88,542.
ARR, Accounting Rate of Return, gives an average ratio of 13% which more than Option 1
Manufacturing Company has all advantages to go for option 2 with the NPV greater than zero,
IRR more than Company expected rate of return, payback more than Option 1 one from Year 6
and ARR ratio more than zero and option 1 one.
These capital budgeting methods are crucial for business long-term investment decision. On top
of it risk factors need to be assessed to close the decision. These longer-term expenditure
decisions must be evaluated logically to determine whether an investment can be justified and
what rate and duration of payback is likely to occur (Walther & Skousen, 2009).
References

Heisinger, K., & Hoyle, J. B. (2012). Accounting for Managers [Digital Edition version].
Creative Commons. Retrieved from https://2012books.lardbucket.org/books/accounting-for-
managers
Walther, L. M. & Skousen, C.J. (2009). Managerial and Cost Accounting. Retrieved from
https://library.ku.ac.ke/wp-content/downloads/2011/08/Bookboon/Accounting/managerial-and-
cost-accounting.pdf