The new automated assembly line will be requiring the purchase of five new robots, each costing $32,000 and associated gripping devices costing a total of 65,000. Roller tracking and new assembly fixtures will also be needed adding up to a cost of 15,000. The new assembly cells will be manned by three cell programmers/operators who will be paid 20,000 each. The finance department estimates that installing the automated system will generate an annual cost savings of 5,000 due to the reduction in reduction in scrap and rework. After five years, the robots can be sold each with a market value of 1000.
This report will analyze the possibility of investment in the new assembly line by utilizing financial management tools. The first section will look at the annual expected cash inflows and outflows. The next will be an analysis of the investment through the use of capital budgeting tools like payback period, return on investment, net present value, discounted payback period, internal rate of return, and sensitivity analysis. Recognizing that numbers don’t tell all, this report also goes beyond quantitative analysis by also looking at the quantitative issues which should be considered by the firm.
Table 1 shows the expected annual cash flow that our business organization hopes to incur in the installation of the automated assembly line. During the first year, the company expects a total cash outflow of £240,000 in order to finance the initial investment in robot costs, gripping devices, and roller tracking and assembly fixtures. The first to fourth years are forecasted to generate cash inflows of 93,000 annually which reflects the cost savings from rework and scrap and the elimination of the cost incurred in hiring fitters offsetting the salaries of the computer technician. During the fifth year, the company will be incurring the same costs and benefits together with the expected salvage value of the robots.
The payback method is one of the most popular tools in conducting capital budgeting decision. The payback period tells the company the length of time required to recoup the original investment through investment cash flows. This is essentially the time when the company breaks even-the initial capital outlay is equal to the cash flows. Considering that the business organization invests in a project which generates the same level of cash flow annually, the payback period is computed as follows:
Payback = Initial Investment
Annual Cash Flow (equation 1)
However, if the investment generates unequal annual cash flows, then the individual annual cash flows are subtracted from the initial investment until a difference of zero is reached (Lightfoot 2003). The year when cash flow equals investment is the payback period. Other things being equal, the investment with a low payback period is chosen as it implies less risk for the company.
Table 2 shows how the payback period for the proposed automated assembly line. As the investment yields unequal cash flow for the five-year period, this report simply subtracted the yearly cash inflow to the total amount of the investment. The cash outlay for the proposed project is expected to be recouped in 2.58 years.