The project has a positive net present value with a higher figure which makes it worthwhile for the firm to peruse in making their stakes. After the three years, a positive return will be gained by the investors (Alnoor 2017). The value of revue is higher than that of costs in the project, which makes the NPV be a positive amount. The investors, therefore, will make higher profits from the investments at a cost-effective rate since the revenue amounts are more significant than the costs and expenses used in the project.
The firm can also employ alternative capital appraisal methods to measure the effectiveness of the project in the three years. The methods are as follows.
The payback period is used to measure the time taken to get back the invested amounts within the three years. Therefore, the firm should engage in calculating the time taken to ensure that eh invested amount is back within the shortest period. The rationale for a quicker return period is to avoid such risks and uncertainties that may come along when the money takes a long time to come back as returns to the firm.
The payback period does not measure profitability but the risk and time taken to make returns form the project. The investments rule is always to for accepting the project that makes returns within the shortest time possible.
Accounting Rate of Return
The accounting rate of return is used to measures the expected profit for the investment operations in the three year (Alnoor 2017). The firm, therefore, can use the net accounting profit estimated from the investment to make a decision on which project will yield the best return for the firm. accounting rate of return methods is also referred to as the return on investments which measures the profitability that one gets for the investment. When the performance is higher, then the investment is lucrative for practice. However, when the accounting profit has a lower percentage, then it should be rejected.
The firm can use profitability index to measure the rate of return the firm will get per dollar in the three years of investment (Alnoor 2017). The amount is arrived at by dividing the present value of the future cash flows by the initial outflow to give the profitability index for the firm. From the calculations, if the profitability index is more than one, then the project is worth taking. When the profitability index is more than one, this implies that the firm has a higher chance of making more enormous profits from the investments opposed to when it is less than one or a negative value that means a loss or relatively lower benefits.
Based on the gross profit margin analysis, company A is a better investment firm compared to company B since it has higher gross margin. Company A has a higher profit return from the investments which are at compared to company B. higher gross profits in company A implies that investing in company B the firm may not enjoy high profits rather be at risk of running losses based on the high-interest rates place on the operating profits. The sales from company B are lower, and this makes their scale of operation to be smaller, and the chances of expansion of making abnormal profits are also limited.
Company A has a higher return on investments compared to company B, and this makes it more lucrative for investors. The net profit form company A, after all, deductions are higher compared to that of company B, and this makes it have a higher return on capital. According to the profitability index and net present value capital evaluation methods, company A provides a better chance for the investors to maximize their performance.
Company A also holds more assets that can be used to run the firm operations. This gives the firm a competitive advantage over company B, which has less asset worth for running its business (Alnoor 2017). However, company A has more debtors than company B, and this makes it to have a higher risk when it comes to debt payments since some debtors can default payments making the firm to wrote off the debts and this can lead to losses.
The debt to equity ratio for company A is lower than that of company B. Company A engages in taking fewer bank loans compared to company B. a smaller bank loan allows the firm to operate at an optimal capital mix state with the combination of debt and equity capitals to maximize its performance.
A lower or short term loan motivates the firm to work harder and meet the loan obligations and make profits from the investments to safeguard its assets used as collaterals. A higher loan increases the firms WACC, and this makes it risky for company B since more senior loans come at higher investment rates and risks due to uncertainties like inflation and mergers and acquisitions.
From the quick ratio analysis, company A has a higher quick ratio than B, implying that company A has enough assets that can be used to prevent it from liquidation by financing the debt obligations. The company, therefore, has a lower risk as investors are assured that the firm can stand for itself to fund its short term obligations. However, in company B, the quick ratio is lower, and this means that the firm’s assets can be easily used to finance the short term obligations during liquidation.
The cash conversion ratio for company A is higher compared to the cash conversion ratio of company B. both companies have excellent liquidity since their cash conversion ratios are above one implying that the firm is sustainable in managing its obligations. However, the cash conversion ratio for company A is higher, and this makes it more attractive for investment than company B. company A presents less risk than company B when it comes to the liquidation of the firm’s assets.
Generally, the investors have the option of putting their stakes in company A in order to maximize their returns. Investors are rational and risk-averse; therefore, the higher risk levels in company B makes it less attractive for investment (Alnoor 2017). However, the high profitability and other financial advantages I company A makes it more attractive for investment.
Investing in company A will maximize shareholder’s wealth and even increase the firm’s profits to reach a supernormal profit as it has competitive advantages from the economies of scale when it comes to assets and financial worth. The investment decision should be in company A.
Alnoor, B. 2017.financial management for technology startups. Accessed may. 18, 2020.
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