Executive Summary The main objective of this report is to evaluate whether Amaryllo Ltdshould purchase a new machine to manufacture product ‘HD iCam’ for a four-yearperiod as it operates in an industry which is rapidly developing. The findings of the report reveal that the proposed investment in ‘HDiCam’ is financially acceptable based on the net present value(NPV) and internal rate of return (IRR). Additionally, all investments projects cannot entirely be described interms of monetary costs and benefits; non-monetary aspects are also relevantand should not be considered as less important. Companies differ in theirapproach to pricing. The most suitablepricing approach for Amaryllo Ltd to implement is determined. This report is prepared for the Board of Directors of Amaryllo Ltd whohave to make a capital investment decision.
Table of Contents: Net present value of the proposed investment in ‘HD iCam’ 4 Internal rate of return of the proposed investment in ‘HD iCam’ 5 Comparison of the two approaches to making capital budgeting decisions. 6 Monetary and non-monetary aspects. 6 Most suitable pricing approach. 7 Conclusion. 8 References. 9 Netpresent value of the proposed investment in ‘HD iCam’The NPV of theproposed investment in ‘HD iCam’ is £160,456.
15 at the discount rate of 12%. The NPV is positive therefore the proposed investment isfinancially acceptable and if accepted the shareholder wealth will increase by£160,456.15 (Mackevi?ius and Tomaševi?, 2010).
Figure 3: Notes relating to the estimation of NPV Internalrate of return of the proposed investment in ‘HD iCam’The IRR of theproposed investment in ‘HD iCam’ is 17.37%. The proposed investment is financially acceptable since the IRR is higher than the discount rate used byAmaryllo Ltd (Bosri,2016). The proposed investment is also accepted if the company’s hurdle rate is lower than the IRR (Kierulff, 2008). The company’s hurdle rate is not provided. Assuming thecompany’s hurdle rate is above 17.
37%, this proposed investment should berejected. However, if the hurdle rate is below 17.37% this proposed investmentshould be accepted. Comparisonof the two approaches to making capital budgeting decisionsNPV and IRR are the capital budgeting techniques typically used toevaluate investments. The time value of money and all the cash flows of the project over its useful life is considered.
IRR is preferred in individual investments. In comparison, NPV ispreferred in mutually exclusive investments (Bosri, 2016). NPV is expressed interms of currency, whereas IRR is expressed as a percentage and it is easilyunderstood (Arshad, 2012). The timing of cashflows and size of projects can give contradicting NPV and IRR results. Forinstance, when a project returns cash instantly, NPV is lower and IRR is higher(Kierulff, 2012). The NPV methodassumes that cash flows are reinvested at the project’s discount rate, whereasthe IRR method assumes that the cash flows are reinvested at the project’s IRR (Bosri, 2016). The reinvestment assumption of NPV provides a morereliable result.
NPV takes into account additional shareholder’s wealth whencalculating the profitability of the investment, but IRR does not (Arshad, 2012). NPV can be used toevaluate investments where there are changes in cash flow, but the IRR methodcannot. If there are multiple sign changes, there would be multiple IRR results(Kierulff, 2012). Both NPV and IRRhave their benefits and limitations.Monetaryand non-monetary aspectsAll investments projects cannot entirely be described in terms ofmonetary costs and benefits; non-monetary aspects are also relevant. Thenumerical analysis is important in order to estimate the costs and benefitsinvolved in a particular project. Also, the most feasible investment project isevaluated using the quantitative investment appraisal techniques (Drury, 2015). The decision ruleof these techniques is easy to understand.
Lastly, the techniques are simple tocalculate (Bosri,2016). However, the qualitative factors might lead to a decision whichcontradicts the results of the investment appraisal techniques. Many non-monetary aspects are not easilytranslated into monetary terms and are difficult to evaluate, this could be dueto their intangible nature (Lindvalland Larsson, 2017). This means that it is notworthwhile to implement non-monetary aspects into the company. On the other hand, it is important to includenon-monetary aspects into the company. For the reason that all stakeholdersshould be considered equally, not only shareholders but also employees, thecommunity, customers and environment for asuccessful investment appraisal (Bamber and Parry, 2017).
The customer satisfaction is an importantqualitative factor to consider when deciding whether to accept the proposedinvestment (Götze,Northcott and Schuster, 2008). Amaryllo Ltd has spare capacity in itsexisting factory and the purchase of this new machine is likely to increasecapacity. Higher capacity utilisation can reduce unit costs, satisfying thecustomer’s needs. Very high capacity utilisation can meet the demand for ‘HDiCam’ and when performing at a very high productionlevel means less time can be spent on quality control (Drury, 2015). This can damage Amaryllo Ltd reputation, resulting inunsatisfied customers and a decrease in sales. The implementation of corporate social responsibility(CSR) programs create a competitive advantage and distinguish them fromcompetitors. Hence, the corporate image and reputation are improved (Lindgreen andSwaen, 2009). However, the manufacture of ‘HD iCam’ canalso increase competition as Amaryllo Ltdoperates in an industry which is rapidly developing.
The competitors mayrespond by starting a price war. Theexisting employees will operate in the manufacturing of ‘HD iCam’. Hence, employees will need to be trained, this may notbe effective and delay production. Employeemorale is very important they can become stressed and demotivated due to aheavy workload. Customers will notice these unhappy employees. For that reason,employee morale is an important qualitative factor to consider (Lindgreen andSwaen, 2009).The impact on the environment should also be considered (Meyer and Kiymaz, 2015).
The new machineshould manage waste and energy efficiency for example when it is not requiredit should be switched off. Ultimately, the final decision should take intoconsideration the qualitative factors for a successful project appraisal. Mostsuitable pricing approachThe three most common pricing approaches that companies employ include cost-based pricing, competition-based pricing and demand-basedpricing (Pride, Hughes and Kapoor, 2016).AmarylloLtd can take all of the pricing approaches into consideration to determine theselling price of ‘HD iCam’. There are a number of reasons why competition-based pricing is not asuitable approach. First of all, customers could be willing to pay more ifAmaryllo Ltd prices higher than its competitor’s. However, if Amaryllo Ltdchooses to price lower than its competitors’, customers may doubt the qualityof ‘HD iCam’.
In addition, production costs may be ignored if the companyfocuses on the prices set by competitors. Finally, Amaryllo Ltd can be forcedinto price wars and may need to find new ways of attracting customers (Faith and Edwin, 2014). Cost-based pricing is also not a suitable approach. It is difficult todetermine the accurate costs of producing ‘HD iCam’. This is because theinflation rate has been assumed to be a constant rate of 5% on selling price and8% on variable cost.
Furthermore, if costs increase somust the price to produce a profit. Itdoes not consider what customers are prepared to pay. The approach ignores demand, the price elasticity ofdemand and its competitors’ prices (Singh, 2013). The purchase of the new machine to manufacture product ‘HD iCam’ has ashort product life-cycle. Therefore, price skimming is a useful strategy forAmaryllo Ltd to introduce.
This involves setting a high price initially inorder to maximise short-term profitability then settle at a reduced price (Singh, 2013). Amaryllo Ltd is a worldwide pioneer in home securityrobotics so price discrimination strategy can also be used. Pricediscrimination is charging different prices to different customers. In thiscase, Amaryllo Ltd can market ‘HD iCam’ at different prices indifferent countries (Pride, Hughes and Kapoor, 2016).The mostsuitable pricing approach that Amaryllo Ltd shouldselect is demand-based pricing because the customer is the foundation of asuccessful business (Faith andEdwin, 2014).
Hence, customer loyalty and customer retention can be achieved withsatisfied customers. However, with unsatisfied customers, Amaryllo Ltd could go out of business. In comparison to the cost-based and competition-basedpricing, demand-basedpricing considers what customers are prepared to payand setsa price based on customer demand (Pride, Hughes and Kapoor, 2016). This approach allowsAmaryllo Ltd to set the maximum possible price to charge customers in order tomaximise profits.
ConclusionThis report presented and discussed whether the worldwide pioneer inhome security, Amaryllo Ltd, should purchase a new machine to manufactureproduct ‘HD iCam’. Hence, both the NPV and IRR calculated suggested that theproposed investment is financially acceptable. Additionally,allinvestments projects should consider the non-monetary aspects, such as the action of the competitors and the impact on theenvironment, as well as the monetary costs and benefits.
The most suitablepricing approach that Amaryllo Ltd should prefer is demand-based pricingbecause the customer’s perceived value of the product is more important thanthe competition and the cost of making ‘HD iCam’.