Question

Alexander Inc. is considering four proposals for the construction of new facilities. The Accountant is supposed to evaluate four proposals.

	Proposal 1	Proposal 2	Proposal 3	Proposal 4
Payback period	3 years	4 years	4 years	7 years
Net present value Internal rate	$80,000	$178,000	$166,000	$308,000
of return Accrual accounting	12%	14%	11%	13%
rate of return	8%	6%	4%	7%

Required:

How can this information be used in the decision making process for the new facilities? Does it cause any confusion? Which is the best proposal in your overview and why?

Answer 1

The following data provided information about various proposals to decide among them which one is the best to select. These informations are useful as they will help in finding out the best proposal to br selected by comparing different parameters.

Coming to the first Net Present Value (NPV), any project should be selected if its NPV is greater than zero. Here we see all the proposals have their NPV greater than zero. Means that each project is profitable to be invested on. But while selecting the best one out of all four, we wil look for project with highest NPV, that is proposal 4 has the highest NPV and hence depending on NPV proposal 4 is best to opt among others.

If we compare the proposals on pay back period, proposal 1 is the best to be choosen because it has the capacity to pay back the investment amount earliest than the others.

If we compare the proposals on Internal rate of return, the project with highest IRR is to be selected as it will give the highest return in comparison to others. Here proposal 2 is the best to be choosen if the base is IRR as proposal 2 has highest IRR.

If the projects are compared according to Accrual Accounting rate of return, proposal 1 has highest ARR, and hence this should be selected among all the others for investment.

As we can see some proposals have highest NPV but less IRR or the pay back period is very long. So it's really confusing to judge which one to select and which not. We have to look on every parameters in a very fine manner.

According to me, NPV and IRR is the best method to look for selecting projects. We can see that proposal 4 has highest NPV but when considering the time it is taking to repay is very long and has a huge difference from time zone of other projects. So this is not very good to go with. Second position according to NPV is of proposal 2, which has a shorter pay back period that is 4 years. And it also has the highest IRR. Hence looking on all the factors according to me, proposal 2 is the best proposal as it has highest IRR and NPV is also more with shorter pay back period. The company should invest on proposal 2 therefore.