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The financial feasibility of a capital expenditure. Pevensey Plc. - Essay Example
Pevensey Plc is in the process of evaluating the financial feasibility of a capital expenditure which pertains to the purchasing decision of a machine. The procurement department of the company after careful deliberation and consideration have short listed four machines which are suitable and possess all the required functionalities. …
The head of the production department has approved all the short listed machines and now the decision rests with the financial control unit in order to evaluate the financial feasibility of the purchasing decision. Future cash flows have been forecasted and are presented as net cash inflows. The cash outflows comprises of expected repair and maintenance expenditure over the useful life of the asset. Whereas, the cash inflows includes the expected total revenue generated by the machines in the form of sale of the products manufactured by the machine. All the projected cash flows include the impact of expected inflation. The capital expenditure pertaining to the purchase of machine has been decided to be funded through internally generated funds. Therefore, keeping into consideration the limited amount of the funds, the directors of the company must make prudent investment decision so to achieve the most lucrative and appropriate results.
The method used in the investment appraisal is determining the Net Present Value (NPV) of each proposal. According to this method, the future expected cash flow, over the time span of the project, are discounted based on the expected discount rate in the economy. As per the treasury department of the company, the cost of capital of the company is 9%, which is used as the discount rate in calculating the NPV of each project. The expected cash flow from each year is multiplied by the discount factor to arrive at the present value at year 0 i.e. at the time of making of the capital expenditure. An investment whose NPV is positive is considered to be a rewarding one, whereas an entity does not venture on an investment where the NPV of the cumulative cash flows is negative. Where the management has to rank the investments, with the objective of giving priority to the most rewarding ones, the investment with the highest NPV must be ranked first. ...