Athena Company Case

Internal Rate Return (IRR)

             The internal rate of return calculated for machine Venus and machine Adonis are presented below with the formula used for calculations of results.

ARR is calculated by dividing the average net profit by average investment. In these calculations, average net profit is calculated by adding up all cash inflows and then dividing the calculated amount by the number of years. While on the other hand average investment is calculated through subtracting the book value at the end of the useful life of machine from the book value of machines in year 1.  

Accounting rate of return (ARR) calculated for machine Adonis and machine Venus are 0.82 and 0.84.

Market Research

The company carried out the market research of £6000 one year previous to the year 0 (the year of purchase). In accordance with the accounting and finance management concepts this cost should be also included in the cost of machines as indirect cost or MOH. Somehow, if the market research cost was not related to the purchase of these two machines then management should not include that cost in the overall cost of machinery. 

Advice for Athena Company 

Athena Company has some financial difficulties particularly associated with the cash flow from the last few years. The company has two machines that have different cash inflows annually. According to the case the company wants to replace one of these machines. In the light of above-mentioned calculations, the company should replace machine Adonis as it has a relatively low rate of return. Machine Venus has payback period smaller but net present value better than machine Adonis. Thus the calculations indicate that the company should replace Adonis machine to get financial advantages.

Advantages and Disadvantages

Payback period refers to the length of the time duration an investment or asset purchase take in recovering the total initial investment or cost spent by the company. While on the other hand net present value refers to the measure of profitability. The major difference between net present value analysis and payback period calculations is that NPV calculates currency and payback period calculate time duration. Somehow, both techniques and methods have some advantages and disadvantages that should be taken into consideration while making the selection of these techniques or methods for the calculation of profitability and return on investment. Advantages and disadvantages are enlisted below.        

·         Advantages of the payback period

·         Provide information about the time duration required to get back invested amount

·         Support managers in making selection of investment opportunities as relative risk can be measured through the payback period.

·         Payback period also describe preferences for liquidity

·         Payback period is quite easy to understand for managers and investors

·         Payback period is also useful for situations when industries have uncertainties.

·         The payback period can also reduce the possibility of loss through obsolescence

·         Disadvantages of the payback period

Major disadvantages of the payback period are presented below in points

·         Payback period results are not realistic

·         There is no consideration of the time value of money in payback period calculator, therefore, it cannot present the highly accurate results

·         Payback period ignores the salvage value and value of the asset after the useful life

·         Payback period also fails to provide clear information about the return on investment

·         Payback period does not cover all cash flows (efinancemanagement.com, 2019)

·         Advantages of net present value (NPV)

·         Net present value also provide information about the time value of money

·         Net present value provide a clear understanding of the investor about future cash flows

·         NPV also pay focus on the cost of capital (Ross, Westerfield, & Jordan, 2008)   

·         NPV consider risk inherent

·         Disadvantages of net present value (NPV)  

·         Net present value sometimes fails to provide appropriate information regarding the discount rate.

·         Net present value technique does not provide detailed information when investment concerns with unequal life (Ross, Westerfield, & Jordan, 2008).

NPV fails to provide clear information in case of unequal investment amount for mutually exclusive investment projects.    

References

efinancemanagement.com. (2019). Advantages and Disadvantages of Payback Period. Retrieved 02 08, 2019, from efinancemanagement.com: https://efinancemanagement.com/investment-decisions/advantages-and-disadvantages-of-payback-period

Ross, S. A., Westerfield, R., & Jordan, B. D. (2008). Fundamentals of Corporate Finance. Tata McGraw-Hill Education. Retrieved 02 08, 2019

Appendix