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REPORT AND RECOMMENDATIONS FOR MORTONS ENGINEERING LTD

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Introduction

REPORT AND RECOMMENDATIONS FOR MORTONS ENGINEERING LTD TO: MANAGING DIRECTOR OF MORTONS ENGINEERING LTD FROM: AMY JACKSON PRODUCTION ASSISTANT INTRODUCTION Mortons Engineering Ltd manufacture and supply parts for the railway industry. This report is designed to look into modernising and restructuring the production line. This will involve the purchase of a new computerised system, which will enable the company to expand its current level of output. Using the current level of output and production to forecast cash flows, the three systems will be evaluated using investment appraisal and recommendations made as to which one will be best suited to Mortons engineering Ltd. METHODOLOGY Investment appraisal (also known as project appraisal) is used to make financial decisions on whether or not to invest in a project. It is a methodology for calculating the expected return based on cash flow forecasts of many, often inter-related, project variables. Risk emanates from the uncertainty encompassing these projected variables. The evaluation of project risk therefore depends, on the one hand, on our ability to identify and understand the nature of uncertainty surrounding the key project variables and on the other, on having the tools and methodology to process its risk implications on the return of the project. A capital investment decision is like any other decision with certain distinctive characteristics: it involves high levels of expenditure, it will be made for a long time scale, these decisions are not easily reversible and are taken relatively infrequently, consequently the decisions to invest become a critical part of the business plan. The types of investment decisions against which investment appraisal can be applied include: * Expansion of buildings, plant, equipment and stock * New product lines, business diversification and new enterprises * Cost savings, such as technology versus labour * Whether or ...read more.

Middle

The NPV investment appraisal method works on the simple, but fundamental, principle that an investment is worthwhile undertaking if the money got out of the investment is at least equal to (if not greater than) the money put in. It considers all relevant cash flows associated with a project over the whole of its life and adjusts those occurring in future years to their 'present value' by discounting at a rate called the 'cost of capital'' thus the NPV technique is concerned with the time value of money, �1 is worth more today than �1 in the future. The reason being that it could be invested and make a return (even in times of low interest, so long as interest rates are positive). It works on the principle that over time, the value of money goes down (inflation), �100 today will be worth less in two year's time. The cash flows are converted to their present value equivalents by multiplying them by an appropriate NPV discount rate. In general terms we can express the NPV of an investment project as the sum of its net discounted future cash flows. To emphasise this point further, it is vital to understand that once the fact is accepted that money has a time value, then it follows that money at different points in time is not directly comparable: �1 now cannot be directly compared with �1 next year, and so the cash flows of a project that arise at different points through time all have to be converted to a value at one particular point in time. By convention, and because it has many practical advantages, the point in time normally chosen is the present. ...read more.

Conclusion

The reason behind this recommendation is purely from the financial view that this system has the highest return on investment and is the only system, which has a positive NPV. It also has the shortest payback period meaning it is the least risky of the three systems as well as covering the initial capital costs the fastest. It will need to be taken into consideration that these recommendations are based on cash flow forecasts, any variation in these forecasts, or if a different discount rate is used, could cause these results and therefore recommendations to change. "Cash flows are difficult to estimate, especially so when estimating for five or ten years ahead, therefore, variances in these estimates may affect overall decisions". (HNC Business, p201, 2000) The main downside to system 1 is the high number of staff reductions required. This may demotivate remaining employees causing lower levels of output and production, the effects of which would be that future cash flow estimates will be incorrect. If the Managing Director agrees with these recommendations and authorises the implementation of system 1, the project will need continuous monitoring so that changes can be made if any unforeseen events happen. At the end of the project, a post-completion audit should be carried out in order to make use of what can be learned from the experience in the planning of future projects. It will look at how it was thought of, analysed, chosen, implemented, monitored and so on. The purpose of the post audit is to test whether capital budgeting procedures have been fully and fairly applied to the project under review. This may point out mistakes or successes that may then be avoided or replicated in the future and provide feedback which can contribute to performance evaluation. ...read more.

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