Introduction
Before any project can be implemented, there are many steps it has to pass through before it can be proven to be viable (Brigham & Ehrhardt, 2010). These procedures are:
- Identification of a business opportunity or idea,
- Drafting of the project proposal,
- Project analysis and evaluation,
- Implementation and post implementation review.
The objective of this paper is to define and outline the techniques that the management can use to analyze the proposed project of Sapien*TCS in order to determine if it is financially viable.
Review of the Sapiens- Tip Confirmation System (TCS)
The project under analysis is a proposal of investment in the Sapien-Tip Confirmation System (Sapien*TCS) which is an alternative diagnostic and treatment system to the chest X-ray method which is used to diagnose and treat chest problems in adults. The project involves no alternative financing and could easily be financed by its own revenues. The marketing of the product can carried out through Bard as a channel. The system seems very efficient economically as it is described in the paper, but the main question is whether it is financially viable or it is not.
Significance of capital budgeting
Capital budgeting is the process of analyzing a given project through certain techniques to determine its viability (Cadle & Paul, 2010). The reasons that it should be performed in a certain way are the following.
- It helps outline the potential risks that may be faced once the project is implemented.
- It aids in analyzing the financial aspect of the project in a real business environment.
- It is the main tool that prospective investor will rely on.
Source of data for capital project analysis
The projected figures in the proposal should be the data that was used in evaluation of the project. Replacement project analysis and evaluation technique are used where the incremental cash flows (cash inflow and cash outflow) are implemented to determine whether to replace the current chest X-ray and Fluoroscopy machines or not.
Projected incremental annual cost.
Projected cash inflow (annual savings).
The projected incremental annual cash inflow will be $ 454,900, and the incremental cash outflow shall be $181,500. Thus, the number of years and the rate of discounting will be defined and estimated by the financial management team after considering the current and prevailing factors.
Techniques in Capital Project Analysis
The following techniques can be used to evaluate the Sapien*TCS project. These techniques are diverse, and their use depends on the kind of data available, the experience of financial managers and their relative ease of use.
Discounting approach techniques
The discounting techniques use cash flow information projected like the one in the Sapien*Proposal paper. There are two major categories of the discounting technique. They are the discounting and non-discounting techniques. The non-discounting method does not account for the time value of money, while the discounting method recognizes the time value of money, and this is their main difference (Cadle & Paul, 2010). The method that seems to be suitable in the Sapien-Tip Confirmation System project is the discounting technique.
Net present value
The required information and data under this model are the discounting rate, incremental cash inflow ($ 454,900), incremental cash outflow ($ 181,400), and the number of years the project will be in operation.
All projected future cash flows of the Sapien*TSC project will be discounted at the chosen discounting rate according to the period in years using the formulae below.
NPV = Present Value of cash inflows less Present Value of cash out flows. The selection criterion is to choose all the projects with the positive NPV and reject those with the negative one.
Profitability index
Profit index = Present Value of cash inflows divided by present value of cash outflows.
The selection criterion is to choose the Sapien* TSC project if its Profitability Index is equal or greater than one, i. e., it is not equal to zero (0).
Risk based techniques
To accommodate the stand alone risk in the Sapien*TCS project, other techniques that can be used are listed below.
Sensitivity and Scenario analysis using computer aided software
According to this approach, a percentage change in revenues is determined for a given change in the independent variables. The selection criterion is to choose the revenue or cash flow model that holds for greater changes of independent variables (Mian, 2011).
Monte Carlo Simulation
Using statistics software like SPSS, random values are generated that reflect a given outcome, and after several runs, a probability of getting a positive or negative NPV is automatically calculated. The selection criterion is to choose the Sapien*TCS if it has more than 50% chance of the positive NPV (Brigham & Ehrhardt, 2010).
Alternative factors to consider
Financial viability is not the only factor to consider in the project analysis. There are other non-financial aspects that should be considered. They include the following points.
- Strengths, weaknesses, opportunities and threats (SWOT) of the organization that wishes to implement the project.
- Health impact of the proposed equipment.
- The best practices adopted by other similar organizations using the same technology.
Stakeholder Mix
The essence of including stakeholders in this process is to reduce the chances of resistance to change once the project reaches implementation stage.
Internal stakeholders
The internal stakeholders are those people within the organization whose roles are defined as following:
External stakeholders
These are the parties outside the organization that will directly or indirectly be involved in the project implementation process.
Recommendation and Conclusion
The choice of the right technique to be used by the financial management team will depend on the availability of equipment required by each technique, such as availability of computer software, the experience of mangers in using the techniques and their relative ease of use/ application. However, I recommend the application of NPV as it is a simple and quick technique to be implemented.
References
Brigham, E. & Ehrhardt, M. C. (2010). Financial Management: Theoryand Practice. KY: Cengage Learning.
Cadle, J. & Paul, D. (2010). Business Analysis Techniques: 72 Essential tools for success. London: BCS The Chartered Institute.
Mian, M. (2011). Project Economics and Decision Analysis: Deterministic Models. Cincinnati: Penwell Books.