Project Management

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Project Management
Dr Nazim Taskin

Assignment Two

Date: 17 May, 2013
To: Joe Bloggs, Director of EGCM Ltd.
From: Beachen Investment Consultancy Ltd.
(Head Consultant).
Re: Analysis of which proposal deserves an investment of $20000. Thank you for allowing us to work with your company. We hope our services can ease your decision and lift some of the weight from your shoulders. As requested, we have evaluated the two given proposals and through utilising various methods of assessing them, we present to you an informed suggestion as to the advantages and disadvantages of different methods, as well as some recommendations for which steps should be taken next. Both proposals can be seen as having advantages and disadvantages, many of which will be discussed throughout this memo report.

The Payback Period Method:
Proposal A.
Year| Cash flow| Balance|
0| (20,000)| -20000|
1| 3200| -16800|
2| 3200| -13600|
3| 3200| -10400|
4| 3200| -7200|
5| 3200| -4000|
6| 3200| -800|
7| 3200| 2400|
6 years + (800/3200) = 6.25 years.
Proposal B.
Year| Cash flow| Balance|
0| (20,000)| -20000|
1| (2000)| -22000|
2| 2675| -19325|
3| 3200| -16125|
4| 4550| -11575|
5| 6550| -5025|
6| 7000| 1975|
7| 8000| 9975|
5 years + (5025/7000) = 5.718 years.

A- 6.25 years
B- 5.718 years
This method is often used to arrive at a decision due to its simplicity and the fact than nearly anyone with any level of accounting knowledge can understand it. However in saying this, if used regularly the payback period method can promote carelessness, as it does not take into account all expenses involved in an investment, like the time value of money, training and future maintenance, alongside other intangible costs like loss of time and increased workload for workers (Puxty & Dodds, 1988). The payback method clearly shows that proposal B will be paid back sooner as proposal A takes 6.25 years, whereas option B merely takes 5.718 years. This saving of 0.532 years can be a significant advantage to the company not only saving money, but saving valuable time which can be channelled into other areas of the business to generate extra revenue. The payback method is a good filter for the other methods to be discussed, as whenever a project proves unfavourable in this respect, it can incur the same reflection in more in more detailed methods. The most significant component that this method does not take into account is definitely the time value of money. Not taking this into account is referred to as somewhat unsophisticated and primitive and a considerably more detailed and adequate method that does take into account the time value of money is the net present value method (NPV). The net present value (NPV) Method:

Proposal A.
Year| Inflows| Outflows| Net Flow| NPV|
0| | 20000| (20000)| |
1| 3200| | 3200| 2909.12|
2| 3200| | 3200| 2644.48|
3| 3200| | 3200| 2404.16|
4| 3200| | 3200| 2185.6|
5| 3200| | 3200| 1986.88|
6| 3200| | 3200| 1806.4|
7| 3200| | 3200| 1642.24|
| | 15578.88|
| Less Initial Outflow| (20000)|
| NPV| -$4421.12|
| IRR| 3%|
Proposal B.
Year| Inflows| Outflows| Net Flow| NPV|
0| | 20000| (20000)| |
1| | 2000| (2000)| -1818.2|
2| 2675| | 2675| 2210.62|
3| 3200| | 3200| 2404.16|
4| 4550| | 4550| 3107.65|
5| 6550| | 6550| 4066.895|
6| 7000| | 7000| 3951.5|
7| 8000| | 8000| 4105.6|
| | 18028.23|
| Less Initial Outlay| (20000)|
| NPV| -$1971.90|
| IRR| 8%|

Whenever the NPV shows a negative value, it is usually recommended to reject the project. The NPV for proposal B shows a negative value of -$1971.90, meaning that it will yield a negative cash flow and ECGM would be better off simply investing the money in the stock market at 10% for seven years. The net...
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