Explain the basic decision rules

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Reference no: EM132880829

ACCT 71024 Financial Management and Business Strategy

Background

The family have had difficulty in retaining qualified pharmacists once they have been fully trained. They have a spacious behind the counter area for dispensing and feel that they could easily fit an automated dispensing machine in there to take the pressure of the pharmacists'. They have researched the options available and found a model that costs €250k. It would have a scrap value of €50k at the end of five years. With the machine in place they could reduce requirements for pharmacist hours and also take on orders from some more large nursing homes. They forecast that with the reduced salaries and increased sales they could generate additional profits of €60k, €65k ,€80, €80k and €90k over the first 5 years of the project.

The family could introduce their own cash for the project and they know that it should be valued at a rate equivalent to the cost of borrowing for them which is currently 9%.

However the second eldest in the family who has also been very actively involved in the business over the years feel that the business should diversify. A premises has come up for sale right next door to the pharmacy. It would have the same shared access to off street parking as the pharmacy but separate doors right beside the pharmacy door, at both back and front. She believes the premises are perfect to set up a day spa across the three floors of the building. Total cost of the building, the fit out and the stock would be €500k. She believes that if the family could introduce €250k in funds the bank would lend the rest. Her estimates of profit for the day spa over the first five years are as follows:

The building, equipment and fixtures and fittings would all depreciate at 10% per annum on a straight line basis.

The family would like you to analyse both proposals and recommend to them with reasons which project is to be preferred. In order to do this you will assess each project using the Payback Period (PP), The Accounting Rate of Return (ARR), The Net Present Value (NPV) method and the Internal Rate of Return (IRR) Method. You will explain the basic decision rules for each and how that rule applies to your result. You will then compare the results of both projects.

Attachment:- Financial Management and Business Strategy.rar

Reference no: EM132880829

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