BCL LTD Capital Budgeting Decisions Essay

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Capital budgeting is critical to the business. BCL LTD needs to ascertain the value of investing in the two properties. They both bring income. However, only one of the two projects can remain operational because of the income and the time value of money.

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Net Present Value

Assuming that the project has an average risk, the properties’ expected Net Present Value is as follows:

10.00%Cost of Capital for Average Risk Project
Expected Discounted Cash Flows Probability Weighted)
Property12
Year0.10.1
0-£2,500-£2,750
1£909£818
2£413£579
3£451£601
4£683£410
5£559£435
NPV£515£92
Total NPV£607Probability Weighted

The Net Present Value is essential for validating a project for investment. It can be a single investment project or two alternative projects. The term capital budgeting gives the description of how managers plan significant investments in projects that have long-term implications (Hawawini & Viallet 2011). Some of them include the purchase of new equipment or the introduction of new products. In this case, BLC is considering the option of relocating to a new facility that will lead to the introduction of two critical departments.

Most companies have many more potential projects than can actually be funded. Hence, managers must carefully select those projects that promise the greatest future return (Ittelson 2009). Managers have to make the best decisions using capital budgeting processes because they determine the financial health of the organization.

When using the Net Present Value method, there is the need to find the present value of a project’s cash inflows. Once it is done, they can be compared to the present value of the project’s cash outflows. The difference between the present values of these cash flows, called the net present value, determines whether or not the project is an acceptable investment (Hawawini & Viallet 2011).

The above NPV indicates a positive outcome for both properties. Property 1 has £515 and property 2 has £92. The total NPV is £607. However, property 1 has the highest NPV and hence the best investment property. The business should accept property 1 since it has a higher positive value.

Internal Rate of Return

YearProperty 1Property 2
0-£2,500-£2,750
1£1,000£900
2£500£700
3£600£800
4£1,000£600
5£900£700
Property 1Property 2
The IRR17.67%11.37%

If the project’s cost of capital is 10% then the results will prove the project to select as follows

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Select Property 10.017665611
Don’t Select Property 20.011373058

The internal rate of return usually examines the forecasted rate of return. It primarily considers the useful life of the project. The internal rate of return is computed by finding the discount rate that equates the present value of a project’s cash outflows with the present value of its cash inflows (Di Lauro 2009). In other words, the internal rate of return is the discount rate that results in a net present value of zero. If the IRR is higher, then the project is desirable. Property 1, therefore, becomes the desirable project according to the calculations above.

The payback period

The payback method focuses on the payback period. The payback period as the name suggests, examines the length of time that of a project. The essence is to discover how long it takes to recover the investment using the net cash inflows that it generates.

The payback period

Property 1 remains the best option because it has a payback period that is shorter than that of property 2.

Another qualitative factor is the Balanced Scorecard. The BSC helps the organization to set strategic measures for success. The management then aligns every activity towards achieving the strategies set.

The approximate annual percentage cost of a discount of 2% is as follows;

The payback period

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BLC Ltd has two options to use due to the prevailing circumstances in the company’s financials. The current scheme costs the company £22 million per annum. The new plan costs the company £13,000,000 per annum. According to the firm’s strategy, it is supposed to make more income and cut down on costs. It will be prudent for BLC LTD to choose the new scheme because it will save £9,000,000 per annum.

All of the company’s customers are currently on credit terms. It means that it will be another task to convince 80% to take up the new method of payment. They can work towards improving their payments in a process (Di Lauro 2009). It may take several months before they adapt to the new scheme.

The company should also consider taking up cash customers. They will boost the company’s sales and increase cash flow. The plan will depend on the marketing department’s objectives (Ittelson 2009). If they support the business through extensive marketing of the products, it is achievable

The company will benefit from the new scheme also because it will have cut down on the overdraft. Its assets will increase due to the decrease of the liabilities. Liabilities also affect the company’s ability to pay its shareholders.

BLC Ltd should also reinvest a greater percentage of its income. The plan will enable the company to always have cash for its working capital utilization. The company should also work on its production limits. The risk department should ensure that there is maximum utilization of resources at the disposal. Mass production will also help the company to save on materials and finance (Ittelson 2009). The economies of scale will enable the firm and the customers not to have difficulties in providing the needed products.

It will be prudent for the company to also start working on the incentives for the 20% percent customers who pay within 30 days. The company can also provide a 2.5% discount on such customers and anticipate that about 50% of them will pay on time. The process will cost the company about £1,250,000. However, the plan is to save the company the balance of 1% bad debts totaling £5,000,000.

Reference List

Di Lauro, M 2009, The net present value of life, Renfrew, General Store Pub. House, Renfrew.

Hawawini, G & Viallet, C, 2011, Finance for executives, South-Western Cengage Learning, Mason.

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Ittelson, T 2009, Financial statements, Career Press, Franklin Lakes.

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