The New Heritage Financial Decision Analysis, Essay Example

Reasonable Points of Difference

• The new doll film project has the highest NPV and yet maintains the shortest payback period of 1.05 years
• Unreasonable Points of Difference
• The consolidation of warehouse project has the lowest IRR and NPV, a negative profitability index and has the third best payback period of 8.23 years. This is an unreasonable point of difference.
• The match my doll clothing line project has the second best NPV while has the worst payback period of 9.21 years and the second worst IRR and profitability index.

With an available annual budget of 8.0, the optimal allocation of the budget would be:

The optimum budget allocation is based on the cost of initial investment against the IRR and profitability index. These two factors rank the best projects that need to be funded as they show which projects have the highest return on investment and also how profitable the project is on each unit of currency invested. The payback period has been ignored since the IRR and profitability index provide a much clearer picture of which projects are best funded. As is in the case of the consolidation of warehouse facility. This project has the third best payback period but yet has the worst IRR and NPV. Furthermore it has a negative profitability index.

The profitability index is a very important accounting ratio in many aspects. Namely:

1. It puts into consideration the time value of money
2. It puts into consideration the analysis of all the cash flows for the entire life of the project
3. It does not consider the amount of money invested (scale of investment) into a project but rather gives an analysis of the cost and benefit relationship, depicting the ratio between the project’s present value over the value of the initial project
4. It determines the precise rate of return of any given project
5. It is essential in developing a ranking criteria to determine the order in which projects should be considered regardless of the initial amount of investment required

The last project funded is the consolidation of warehouse facility owing to the fact that it has the lowest profitability index and the highest requirement of initial investment. The project has a negative NPV, 0.62 ? 1. Therefore, even with a higher NPV alternative the project is not fundable.