2 Responses

Response 1:
 
Decision Making and Capital Budgeting
There are many aspects involved in analyzing investment opportunities and such analysis can help determine whether or not an investible is suitable or how it is likely to perform. For this particular discussion, the President of EEC is requesting an analysis of the feasibility to acquire a supplier of component parts.  My team and I will first examine the history of past investments that have similar factors as this scenario to evaluate how mistakes were regarded and what steps were used in the correction process.  We will then take a look at key factors that have essential barring on the decision making process.  According to Investopedia, (2018), mergers and acquisitions allow businesses to:
·  Increase their market share
·  Expand their geographic reach
·  Become larger players in their industries
However, when one company decides to acquire another, it must take the good and the bad. The issues of the company being acquired become the problem of the new company, such as debt, lawsuits or financial records that are inadequate.
In order to determine the best approach to take we must first explore what an Investment Analysis is. “Investment analysis is a broad term that encompasses many different aspects of investing.  It can include the analysis of past returns to make predictions regarding future returns, selecting the type of investment vehicle that best fits the investor’s needs or evaluating securities such as stocks and bonds for valuation and investor specificity (Investopedia, 2018).”
In order to make a decision regarding acquiring the supplier, EEC must evaluate the following:
·  If the supplier is priced right, determining from the very start if the price is a reasonable one. One of the main reasons acquisitions fail, is due to the asking price being outside of the metrics set.
·  Whether or not the supplier has a manageable debt load. The acquiring company should examine the debt load of the other company to determine if it has reasonable debt at a high interest rate so that the larger company would be able to refinance for much less.
·  If the supplier has minimal litigation and clean financial statements. Extremely high liabilities are unusually cause for concern.
Some analysts may argue that all future costs are relevant in decision making and I must say that I disagree, mainly because Accounting-Simplified.com, (2013) describes the concept of relevant costs as those cost that affect cash flow and ignores other costs that have no future effect. It further explains that “Relevant cost, in managerial accounting, refers to the incremental and avoidable cost of implementing a business decision, which is key filtering what is relevant or non-relevant.
“When businesses contemplate making a significant investment in its own future growth, it is said to be making a capital budgeting decision. Capital investments involve the outlay of great amounts of money that companies spend in hopes that the purchase will result in a great cost savings or increase future profits, (Chron, 2013). Capital budgeting decisions fall into 2 broad categories, screening decisions and preference decisions. “A Screening capital budget decision is a decision that is taken to determine if a proposed investment meets a certain preset requirement, such as those in a cost/benefit analysis.  In a preference capital budgeting decision, the company compares several alternative projects that have met their screening criteria, whether a minimum rate of return of some other measure of usefulness and ranks them in order of desirability. The decision makers then choose the investment or course of action that best meets company goals, Chron, (2018).”  I recommend that EEC should use the Screening capital budget decision to determine right from the start whether an investment is worth the time and money.
Overall, to make an informed decision about whether or not to acquire the supplier of component parts, EEC must look at the history of past projects and determine the feasibility to make the investment, realizing that they will also acquire any pre-existing issues the company currently has. They must also factor in the future cost to determine which costs are relevant and may cause an effect. Finally, they should implement the screening capital budget decision and determine if it is ultimately worth spending the time and money to invest.

Response 2:
 
As the Eddison Electrical Company has been confronted with an investment opportunity to acquire one of its largest suppliers, it is vital to gather as much data as possible and analyze the information as it will help attribute to the capital budgeting decision making process by identifying potential profits and inherent risks. Therefore, in order to assist the company in making the best decision, it is important to evaluate the Net Present Value (NPV), Internal Rate of Return (IRR), and that Payback Period of such investment. The Net Present Value is the difference between a company’s present value of cash inflows and its cash outflows over a specified period of time using the simplified formula: NPV = Present Value of Benefits – Present Value of Cost. As an example, let’s suppose EEC offered to buy the supply company for $500,000 with a projected annual cash outflow rate of $50,000 for the first 4 years, equaling a total investment cost of $700,000. Knowing that the annual cash inflows for the company is $200,000, multiplied by 4 years, is equal to $800,000. Hence, utilizing the simplified NPV formula ($800,000 – $700,000 = $100,000) the net present value of the investment is positive and worth pursuing. Even if the NPV was equal to ‘zero’, it would still be an acceptable investment because the return is equal to the required rate of return. However, if the numbers were switched around and the NPV was negative, it would not be an acceptable investment and one that EEC should avoid. To get a more comprehensive and accurate NPV that takes into account the ‘discount rate’ (interest rate used in discount cash flow analysis to determine present value of cash flows) of investing into alternative opportunities such as an annuity, it is best good to use an Excel Spreadsheet (Epic View Media, 2017, Garrison, Noreen, & Brewer, 2012, Investopedia, 2018). 
            The internal rate of return (IRR) is a concept based on whether or not one investment opportunity is greater than the return on investment on another investment opportunity that has equivalent risk and maturity. Thus, the IRR takes into account the return on investment of cash flows from year-to-year, giving a more accurate evaluation of the investment opportunity. Likewise, the payback period, is also helpful in identifying the amount of time it will take the annual cash flows to ‘payback’ the intial investment cost or principle. The payback period can also be compared to other investment opportunities like the NPV and IRR, which will help in the decision making process for EEC (Epic View Media, 2017). In addition, all future cost need to abe analyzed and considered revelant, especially for the decision making process and are typically  pre-determined during the NPV, IRR, and payback period analysis. By considering all future cost as relevant, EEC will have a more comprehansive understanding of inherent risk and opportunity cot associated with a certain investment (Accounting Verse, 2018, Garrison, Noreen, & Brewer, 2012).
            Moreover, when making capital budgeting decisions that involve capital investments such as a possible acquisition, the purpose of doing so should result in increased profits and/or cost savings for the company. Thus, when capital budgeting decisions are made, they fall into two categories known as screening and preference decisions. Screening decisions are those that are based on predetermined criteria such as a cost-benefit analysis. For example, if EEC is going to purchase the supply company for a set amount of money, will the purchase increase its profits by a certain margin in a set period of time, or if the money was invested into a stock, would it earn more money that route. If the answer is the latter, and the cost outweigh the benefits, then there is not an advantage to acquire the supply company and the screening technique worked. However, if utilizing the preference decision model, the organization will compare multiple alternative investments that have passed the screening technique, dependant on the useful measures identified (ROI, IRR, payback period), and rank them in order of desirability or those that best align with the company’s goals. Therfore, it is recommended that Eddison Electrical Company implement the preference decision making model since it is assumed that whatever investment decision is made has already been vetted with the screening method. This adds another layer of security and oversight that will ultimately mitigate the investment risks and render a best case resolution (Garrison, Noreen, & Brewer, 2012, Strain, 2018).

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