Question

1. Explain two (2) non-financial factors a company needs to consider before deciding to approve an investment with positive Net Present Value (NPV)? (4 points)

2. Evaluate the proposed projects below. Based on the information given, which project would you choose to take on? Clearly explain your reasons. (3 points)

	Accounting rate of return	Payback period	Net present value
Project 1	25%	2.25 years	69,700
Project 2	21%	5 years	93,600

Answer 1

1 a) Two non –financial factors

Impact on the employee morale: A firm should ensure the new capital investment has a positive impact on the morale and motivation of the employees. If there is an adverse impact on employees’ motivation it can lead to productivity issues as well as labor law issues. Hence a firm should ensure these factors are taken into consideration

Safety factors: Firms should ensure new investments are safe to employees and public. The safety feature is top priority since firms have responsibility towards employees for safe working condition and ensuring no safety concerns to public. The impact of new project on environment should be carefully evaluated before capex investment. All environmental and pollution laws should be complied with to ensure no ambiguity later.

1 b) An investment in capital budgeting should be committed after evaluation of the same with different methods. ARR is calculated based on net income divided by initial or average investment. Payback period is calculated based on initial investment and its recovery through annual cash inflows. Net present value calculates the returns based on time value of money.

Project 1 is having higher accounting rate of return compared to Project 2 and Project 1 is having lower payback period which means its investment is recovered early compared to Project 2. The Net present value of Project 2 is higher. A firm should choose Project 1 because absolute value of NPV is not a criterion to decide which project to be taken. A firm should ensure it recovers its investment in capex as soon as possible. Project 1 is having lower payback period and higher net income compared to Project 2 which is positive for the firm. Hence Project 1 should be selected. Project 2 is having higher absolute NPV because it can have higher cash inflows and outflows compared to Project 1