Executive Summary.

Introduction

Fresh PLC after conducting its preliminary market research and deducing positive
response from the customer now seeks to check the financial feasibility and viability of
investing in the new project. The report thus aims to provide valid analysis of the project
to the board through the use of main investment appraisal technique. The report
through the use of main investment technique will aim at providing figures and
suggestion about the selecting the new project in the light of the derived figures from the
appraisal. Further the report also aims at assisting the board by developing key
performance indicator to assess the performance of the project.

Forecasted Cash Flow and Outcome of Investment Appraisal.

Utilizing data provided in the case and based on the relevancy of the data with regards
to the case following forecasted cash flow has been developed.

NET CASH FLOW (NCF) CALCULATION

SALES DEMAND 0 170,000 185,000 200,000 195,000 180,000

/Year Year 0 Year 1 Year 3 Year 3 Year 4 Year 5

Fixed Asset Investment -50,000 0 0 0 0 0

Working Capital -15,000 0 0 0 0 0

Sales Revenue 0 102,000 120,250 130,000 117,000 108,000

Less: Variable Cost

Raw Materials 0 25,500 27,750 30,000 29,250 27,000

Packaging Cost 0 8,500 9,250 10,000 9,750 9,000

Bonus 0 1,000 1,750 2,500 2,250 1,500

Total Variable Cost 0 35,000 38,750 42,500 41,250 37,500

Total Contribution -65,000 67,000 81,500 87,500 75,750 70,500

Less: Fixed Cost

Distribution Cost 0 8,000 8,000 8,000 8,000 8,000

Marketing Budget 0 10,000 5,000 5,000 5,000 3,000

Staff Salary 0 30,000 30,000 30,000 30,000 30,000

Total Fixed Cost 0 48,000 43,000 43,000 43,000 41,000

Net Cash Flow before -65,000 19,000 38,500 44,500 32,750 29,500
Tax
Less: 20% Tax 0 3800 7700 8900 6550 5900

Net Cash Flow after Tax -65,000 15,200 30,800 35,600 26,200 23,600

Working Capital 0 0 0 0 0 15,000

Adjusted
Salvage Value Adjusted 0 0 0 0 0 10,000

Final NCF -65,000 15,200 30,800 35,600 26,200 48,600

Outcome of main Investment appraisal technique.

Based on the data achieved from the forecasted cash flow and utilizing main Investment
appraisal technique to analyze them following result is derived:

PBP: 2.5 Yrs.

ARR: 40.62%

NPV: 42687.8

IRR: 34.85% (calculation are done in Appendix2)

Apart from these investment appraisal tool the forecasted cash flow also shows a
positive contribution throughout its life from 67000 in year1 to 70500 in year5 which
further states that the project generates sufficient contribution to cover the variable cost
and fixed cost and result in profit. Thus investing in the project may seem beneficial
based on contribution margin but to further the solidify the decision of investing in the
project the investment appraisal techniques should be analyzed in detail.

Analysis of the outcome of main investment appraisal technique.

The outcomes of investment appraisal are analyzed and to further insure that the
suggestion made from the analysis is valid example from the real life implication of the
appraisal technique are also stated in the following manner.

Payback Period.

Payback period ia an investment appraisal technique that tests the feasibility of the
project on the basis of time taken by the project to recover the amount invested at the
start of the project.

In the cash flow in year 0 there is a negative CCF of (65000) as in this initial year only
investment is made and no revenue is generated thus resulting in excessive outflow
over inflow. In 1st year the CCF was (49800) and the NCF was 15200. In the second
year the CCF was (19000) and the NCF was 30800. In the 3 rd year the forecasted cash
flow presented a positive CCF and NCF of 16600 and 35600 respectively. It thus shows
that the company covers its invested amount in mid of 2 to 3 years and through
calculation of PBP the figure of 2.534 is achieved. Thus using PBP technique of
investment appraisal it can be indentified that it takes 2.5 years for the project to repay
the initial investment through its net cash inflow.

Here, PBP figure solely indicates towards acceptance of project as the investment in
the project is forecasted to be reclaimed within two years. However, intervening PBP
theory, it is evidenced that it neglects the idea of time value of money. Similarly, it
neglects the idea of inflation and other risks involved. (Milis, Snoeck and Haesen, )

Despite its limitation PBP is still widely practiced tool for investment appraisal. The fact
that it can be used as proxy for the economic duration of the project and can be
calculated, used, understood and explained to the shareholders easily has assisted in
sustaining its popularity.(Lefley, F. 1996)

Further, Fourteen fortune 500 companies among which two were the companies among
500 largest corporation were evidenced using PBP for analysis of projects and
investment. This draws the practicality of PBP concept. Additionally the UK supermarket
dominant force Tesco used PBP to analyze the return from investment in powerperfector
system which would reduce its energy usages and foot prints. Consequently, invested
$25 million dollars which is expected to be return in next 5 year.(Mclaney and Atrill
2012)
Accounting Rate of Return

By dividing average annual profit by average investment of the project, accounting rate
of return(ARR) is calculated. Therefore dividing Average profit of 18280 by average
investment of 45000 we get ARR of 67.29%.which when compared with current ROCE
of 25% of company is more, that means its favorable to invest in the project. However,
the percentage of ARR means, you will be earning that percentage on every pound
invested. That means we will return of 67.29% on every pound invested on the project.

Advantages of ARR can be, it is simple to understand and easy to calculate like
payback period. It reflects the total profits or savings over the entire period of the
project. This method fulfills the interest of the holders as they are much interested in
return on investment.(Mclaney and Atrill, 2012)

Taking about drawbacks, it generates problem while making decisions. This method
cannot be applied in a condition where investment in a project to be made in many
parts. It is not useful to evaluate the projects where investment is made in two or more
installments at different times.

NPV
Upon discounting cost of capital we receive the positive NPV of 42687.8 which
indicates the present inflow is greater than the present outflow. As we advocate,
difference between the value of dollar earned today and tomorrow. Each dollar earned
today has a greater value than dollar earned on tomorrow as the concept of time value
of money with respect to various factors as interest rate, inflation and so on. Further on,
project gross increasing cash flow through operation period of 3 years while the figure
fluctuates at the 4th and 5th period contributing towards positive value against
opportunity cost of capital of 12%. Depending exclusively on NPV data indicates
towards acceptance of project.

However, NVP is criticized as calculating discount factor while ignoring other risks. It
depends solely on forecasted Cash flows and it is advocated that cash flows may
manipulate the NPV data as it is calculated at the end of year while company may have
abundant of cash during mid operation period while lower liquidity at end of year
(Pogue,2004).

However, the scenario of JD power showcases the reliability of NPV, where

implementation of NPV forecasted the benefits of investment in improvement of sound
quality of automobiles reducing the cost associated with sound warranty cases. Here,
NPV represented how profit would be up by $1000 with declination of warranty cost
associated with sounds (Cook & Ali,2010) proving the practicality of NPV on empirical
grounds for rising the returns on investment.

IRR
Through the use of internal rate of return tool as an investment appraisal technique for
determining viability of the new project that the company has thought of commencing
the IRR of 34.85% has been achieved. This outcome states that if the company decides
to move forward with the project then will generate return at a rate of 34.85% on the
investment. Further, the rate also represents the percentage at which the project
breaks-even while the rate also results in the NVP of the project equaling zero.

Considering solely on the basis of the acquired internal rate of return (IRR) results it
seems ideal for the company to proceed with the project. The IRR of the project i.e.
34.85% is better than the hurdle rate like cost of capital of 12% as well as ROCE of the
company of 25% thus indicating that the project will likely add value to the company.

IRR though a primary technique for investment appraisal has a few shortcomings such
as its assumption of cash flow to be reinvested at IRR along with assuming that cash
flow will be equally risky in all years. This method also fails to distinguish between cash
flow from sales or operations while there might be case of multiple IRR when a negative
cash flow occurs at some point in future years.

Despite its limitation IRR is a simplistic method to set a benchmark for an investment
and uses cash flow taking into account the time value of the money. Further when used
in conjunction with NVP and other metrics IRR can be a reliable source for investment.

It is because of these feature IRR has risen up as one of the main method for evaluating
investment as 76% of Fortune 1000 company utilizes IRR upto 75 to 100% of time
while making decisions (Kierulff, 2012).

Insurance companies like Aviva have also resolved to using IRR as a means of
evaluating and selecting new business. Aviva aims to generate IRR of around 13% from
its new business ventures. Thus selecting projects based on the IRR as a benchmark
Aviva was able to achieve operating profit of 448m in UK. (Aviva plc Annual Review)

Companies recently have been giving into popularity of IRR by investing in new projects
by setting IRR as a benchmark rate like Forth Ports plc that pursues project that
generates atleast 15% of IRR.

Thus it would be a rational decision for Fresh plc to commence production of new bars
based on its attractive internal rate of return of 34.85%.

Through the thorough analysis of the outcome achieved from investment appraisal
technique it can be stated that the company is poised to benefit from investing in the
new project. However, a company cannot guarantee its success on the basis of the
outcome of investment appraisal and needs to set KPI and monitor performance
regularly and tackle any deviation to achieve success which is possible through
Balanced Scorecard.

Balanced Scorecard.

Balanced scorecard is a management system and performance measurement system

that integrates both non-financial and financial measure to access performance of the
organization (Mclaney and Atrill, 2012). The scorecard assists in translating the
objectives and aims of the business into series of target and key performance measures
in four areas such as Financial, customer, Internal business process and learning
growth(Kaplan and Norton, 2007).

Moreover the scorecard strikes a balance between short term and long term objectives
along with lagging and leading indicators, while forcing managers to focus on the drivers
for future performance rather than that of the past.(Bilble, Kerr and Zanini, 2006). Thus
balance scorecard is ideal means for evaluating performance for the new project of
Fresh plc.

Thus taking into consideration the objectives and vision of the company for the new
project along with trends in the market place following balanced scorecard seems
suitable for Fresh PLC.

Strategic Objectives Measures Targets Initiatives

Priorities
Financial Increasing sales Increase in Net 5% Aggressive marketing
strength profits
Strengthen
financial health Increase ROCE 5%
Standardized
Reducing costs -3% products
Customers Delighting with Healthy inputs 20% Organic Product
healthy and no
products preservatives
-3% Mystery shoppers
Comparably Studying market program
lower cost cost structure

Instantly Reducing lead -4% Value stream

 fulfilling the time
demand
Internal Superiority in Less error and -5% Six sigma
production wastages

Strengthen Supplier cost -5% Team formation of

supply chain saving activities supplier

Reducing storing -5% Purchase order cycle

cost time
Learning and Motivated Team formation 10% Decentralized
Growth workforce

Competent Learning programs 10% Training and seminar

Employee

This Balanced scorecard of Fresh PLC has four perspectives that are interrelated to one
another and achievement of the organizations goal would not be possible if
performance in any one of these perspective is not achieved.

Conclusion.

The report as per the requirement of the board has evaluated the financial viability of
the project based on various investment appraisal technique and based on the outcome
of these techniques such as payback period, Accounting rate of return, Net Present
value and Internal rate of return it is evident that the company will achieve its objective
of increasing profit and sales by investing in the project.
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