Accounting

Investment Decisions, Net Present Value and Bounded Rationality.
The aforesaid article deals with the use of the net present value metric as an important investment appraisal technique in the world while criticizing the fact that the hurdle rate or the discount rate used in real life scenarios by finance managers are based less on theoretical and logical derivation and more on subjectivity and hence reduce the reliability of NPV as an efficient decision making tool as values are usually inflated or deflated. However, the author argues, using theoretical and logical reasoning coupled with relevant figures of behavioral characteristics of managers that it is quite possible that these subjectivities do not act to inflate or deflate NPV, rather are a process of rational decision making as per the internal and external environment confronting business managers and their own understanding of it from time to time.
Hence, the larger argument that the paper focuses on is that of decision making frameworks like the NPV rule only providing one dimension of the problem. Rationality of the business manager in selecting the discount rate is not an impediment to the final outcome of the decision. In effect, a withdrawal from our theoretical derivations or using them along with subjective measures derived from logic may actually increase the quality of the financial management decision making process.
Intangible Benefits Valuation in ERP Projects.
The aforesaid article deals with the use of investment appraisal techniques like NPV and IRR in determining intangible benefits that Enterprise resource planning systems provide to an organization. The cost of maintaining an information system in an organization have become a major component of the overall cost structure and traditional business and accounting tools fail to see the benefits that these information systems provide to the organization. The fact these benefits are not tangible in most cases and have to be shadow priced is another issue. Hence, the article uses relevant examples and theory to stress how companies are today using traditional investment appraisal metrics to value intangible assets and the benefits that they accrue to the firm.
Valuation of Information Technology Investments as Real Options.
The aforementioned article deals with the lack of flexibility that traditional investment appraisal methods such as NPV and IRR represent when undertaking projects of an information technology nature. The problem arises mainly where the one dimensional properties of NPV and IRR do not allow the financial manager to take into account the flexibility of the business manager to abandon, delay or hold onto certain investment opportunities. These kind of opportunities are ever present in the information technology sector where market entry has to be timed in accordance with the availability of suitable ancillaries. For example, Apples Itunes had to be released in tandum with the IPod as both are indispensible and provide a greater competitive advantage. That being said, this does not imply that both were appraised as a single project andor had the same time frames etc.

 Part B Preliminary Evaluation of Proposed Project
The project under consideration by Frank Greystock has many strategic implications. Undertaking the project will allow a massive restructuring and optimization of the firms facilities and lead to operating efficiencies reflected in a higher gross profit. At the same time, the improved reported financial performance together with the effect of a higher future earnings capacity being passed on to shareholders will stem away the downward spiral that the companys share price is in and the threat of a looming takeover.
For this purpose, it is best suited that an NPV and IRR based investment appraisal methodology be used to appraise the financial viability of this project. The decision criterion under the NPV rule is to accept all projects with a positive NPV and in the case of mutually exclusive projects, accept the one with the higher NPV. On the other hand, the decision rule under the IRR mechanism is that where an investment has cash outflows followed by cash inflows, it should be accepted if the IRR exceeds the cost of capital.
The benefit of these types of investment appraisal methods lies in their strong relation to the investor mindset by way of taking the investor mindset into consideration. Specifically, investors are concerned only with cash flows and not distorting accounting income which contains non cash charges when taking investment decisions. This in turn entails that cash flows should be relevant to the decision making process, their timing element should be correctly specified in the financial model and that all incremental cash flows be considered over the full life of the investment including tax savings if any. This is important as a positive net cash flow would imply an addition to the pool of funds available with a firm and hence it is important that any errors or omissions are avoided in order to gauge fully the effect on shareholder values. At the same time, factoring in the timing of cash flows through the use of discounting techniques provides a better tool for analysis as cash flows are directly linked with the opportunity cost to the shareholders of providing funds for the project in the first place.
Hence, as we may see, the NPV and IRR both consider returns from investment with the perspective of investors and provide a fitting appraisal tool. However, the only problem with the IRR technique is its limitation when applied to areas where non conventional cash flow patterns are observed and its reinvestment rate assumption.
The mathematical formulas for both the techniques are given below. Additionally Frank Greystock has also provided us an example of their implementation as per Exhibit 2 of the case and hence a reformulation using the same numbers is not warranted.
NPV 

Where R is the cash flow, the discount rate is denoted by the term I and t stands for time. A summation of all these cash flows for each time period will give us the NPV.
IRR There is no mathematical notation for the IRR and its calculation is done through trail and error mechanisms. We will be using the help of a spreadsheet application to draw out the answer for this.  However, the targeted result of the IRR calculation can be described as below

This is the rate of return (denoted by r) at which the cash flows from a project will return an NPV equal to zero.  Part C Critical Analysis
The concerns raised by different departments with respect to the cash flow that should be used in the capital budgeting exercise are analyzed below and the decision to include  exclude them and to what extent should these be included or excluded have along with theoretical underpinnings in relation to the above are discussed below. However, before we move on to target specific issues, it is necessary to first look at the investor mindset so that we can make an informed decision going forward.
Theoretical reasoning undertakes that investors in a company shares are by virtue of their investment buying a right to an unknown future cash flow. The cash flow is not infinitely unknown, rather, investors in common equity have a moderate idea (say a range of values) of the return to expect from their investments. Hence, while there is uncertainty, there exists an expectation.
Thus, theoretical reasoning suggests that the value of the right to the expected future cash flow is directly proportional to the expected earnings capacity of the firm. The larger the earning capacity, the larger the earnings achieved. The larger the earnings achieved the larger chances of a higher dividend payout, that is, a higher cash flow for the shareholders.
To conclude, management, by virtue of their fiduciary duty to shareholders are required to ensure that they look at investment decisions from the point of shareholders themselves. This is because shareholders are highly receptive of investment decisions as a tool of pricing their investments, taking investment decisions and most importantly, gauging management performance and effectiveness. Thus, the decision to include or exclude a cash flow should ideally come from this common basis of understanding.
Engineering Study
The theory of capital budgeting entails that costs which have already been incurred and are not relevant to the decision making process should be ignored in the analysis. These costs, also called sunk costs, will be paid for regardless of whether the project is carried out or not and hence are not incremental. Hence, the cost of the engineering study should not be taken in the analysis and omitted completely.
Overhead Allocation
As we deal only with incremental cash flows in investment appraisal, overheads that will be incurred regardless of the decision to invest or not should be ignored and only incremental overheads if any should be considered. Here we are not given the information whether these will be incremental overheads or not. We are only asked to adhere to a policy statement of factoring these into the analysis. That being said, although factoring overheads in an investment appraisal exercise needs to be carefully done so as to avoid understatement or overstatement of NPV, they do tend to act as a risk management figure by providing an element of conservatism whenever included.  Hence, we may proceed with factoring these into our analysis.
Cannibalization of Sales at another Company Plant
The theory of capital budgeting has a strong theoretical underpinning to utilize only those cash flows that are incremental in nature and relevant to the decision making process. The cannibalization of sales at another plant within the company suggests that in essence this is not an incremental cash flow and hence not relevant to decision making. This is because, taken together, total company sales will not be affected and only their physical origination will differ.
Use of Excess Transportation Capacity
The use of higher transportation capacity that is already available to the company should not be factored in as a benefit to the company for lowering wastage  non usage of resources. However, as this is an incremental cash flow, the cost of the extra operating expenditure that will be incurred by the cost centre may be included to provide a clearer decision making spectrum. However, these are not specifically available at the moment. At the same time, as the increased throughput will put forward the capital expenditure of the transport division and require investment in specialized equipment related to the English side, these have been factored in accordingly as incremental in nature 
Cash Flow of Unrelated Projects
The cash flow of unrelated projects should not be included in the cash flow analysis of our project. The theoretical underpinning regarding this stems from the fact that different projects have different risk return profiles and those projects that are not financially viable maybe from a strategic business perspective. This lack of conformity with each other leads to the need to separate unrelated projects and consider them separately (Schweser, 2008). Hence, the optimization project currently under consideration should not include the EPC project cash flows as these entail different strategic objectives as well as different risk return profiles. Taking them together may impede the clarity of the investment decision.
Inflation
Capital budgeting and investment appraisal theory entails that inflation be factored in the model so that a clearer decision making spectrum can be created and hence the real value of the investment returns can be gauged. This requires that cash flows and the discount rate should be consistent with each other. At the moment, Greystock has assumed a zero percent inflation environment, that is, all of the figures inputted in his model are at current prices. Since no adjustment has been made (that is the values are all nominal values), the target rate of return or the discount rate should also be a nominal one as investors will demand an inflation adjustment (if cash flows are not adjusted for inflation) as an element of the expected cost of capital .
As we can see, by making the above changes, we will find that our cash flow metrics have become in line with true investor expectations as only incremental cash flows and those relevant to decision making are being considered in the analysis. The reformulations and results of these have been provided in Part D and referenced to Appendix A.  Part D Conclusion
After taking into consideration the above, a revised cash flow analysis table has been prepared and can be found as Appendix One. According to it, the NPV of the project stands at GBP 8.42 Million and the IRR at 24. Please bear in mind that we have not yet taken the effect of a higher operating expense for the transport cost centre. At the same time, as the increased throughput will put forward the capital expenditure of the transport division and require investment in specialized equipment related to the English side, these have been factored in accordingly as incremental in nature. Please note that depreciation on them has been assumed to be straight line with a useful life of 10 Years and no salvage value. Similarly, the overhead allocation has been retained only on account of it acting as a conservative measure. The rest of the concerns have been previously addressed in Part C.
Judging from the above, it seems reasonable to conclude that this project should be accepted as it entails positive NPV and an IRR that is well above the hurdle rate. Undertaking this project will lead to significant cost savings that will improve reported financial performance as well as increase the future earning capacity of the company as reflected by an upswing in share prices on account of higher dividend expectations by shareholders. That being said, it is important to note that this investment appraisal process is a complex one and markets will have to be extremely efficient (from an information receptiveness perspective) and, at the same time, very mature in terms of their receptiveness to complex financial terminology, such as this, for the benefit of a positive NPV to actually pass on to shareholders. If this so happens, shareholders will find the higher NPV reflected in their share prices instantly.