1.1.  Analysis

Several methods are available for evaluating a capital project. For instance, the traditional methods such as the payback period are always very intuitive and easy to understand even for those who do not have a deeper knowledge of finance. The other methods that employ discounting techniques tend to me more complicated. Both the payback period (PP) and the Net Present Value (NPV) techniques are employed in the current analysis.

1.1.1.     The payback period

When analysing an investment proposal under the PP, the decision criteria is to accept all projects that meets the firm’s cut-off payback period (Gitman & Zutter, 2012, p.250). This is often the period its takes for the firm to recover its capital investment in any given project. The present analysis assumes that Wiley will undertake any project that pays back before the end of its 5^th year.

Appendix number 5 shows that the payback period for this particular project is 4.4 years which is shorter that the 5 year cut-off for Wiley.

1.1.2.     The Net Present Value

This appraisal technique focuses on the value of the investment discounted to the present to take care of the fact that money has time value. The decision criterion when analysing independent projects like the current one is always to accept all projects with positive NPVs. Appendix number 6 shows the computation of the NPV for the project pasted from excel. The Internal Rate of Return (IRR) has also been included to show the range of discount rates through which the project will still remain viable. The table below shows the results of the computations.

1.2.  Conclusions

The results of our calculations all shows that Wiley should go ahead with the project. The project recovers its initial capital investment in 4.4 years making it meet the assumed decision criterion of accepting all independent projects that pay back within 5 years. The project also has a positive NPV of $75.83 million at the chosen discount rate of 10%. The project will still be viable even if the discount rate was to be higher with the maximum rate being 27% as indicated by the IRR.

Criticisms of the methods used in investment appraisal

The Payback Period (PP) and the NPV techniques used in the previous section to analyse the proposed project are both financial measures. Like all the other common investment appraisal techniques, the two methods focus on the technical aspects of the analysis. Business decisions are, however, made on the basis of both financial/quantitative and non-financial/qualitative factors (Atrill and McLaney, 2009, p.45).This means that a project that is technically sound may as well not be desirable having regard to the underlying qualitative factors. Besides the general qualitative factors that may be ignored in technical analysis, the various investment appraisal techniques also have their unique shortcomings.

The general criticism of financial techniques

Both the payback period and the NPV techniques are susceptible to the problem of cost escalation (Gitman and Zutter, 2012, p.394). This is simply the situation where management commit to spending on a project simply because some money has already been lost in the same project. For example, Wiley may be driven to pursue the present proposal purely because a lot of money had been spent in buying rights from content providers and carrying out market research. Technical financial analysis tools such as the NPV also fail to recognise wider strategic concerns such as the environmental impacts of proceeding with a given project.

Criticisms of the payback period

The payback method suffers from five (5) main problems. The first of these problems is the absence of an objective criterion for determining the cut-off period (Noreen, Brewer and Garrison, 2011, p.556).This problem is easily discerned from the analysis of the Wiley project in which the cut-off point was just picked using a rule of thumb. The choice of 5 years as the maximum required payback period was not made using any objective rule.

Another weakness of this method is the failure to recognise the timing of the cash flows within the payback period (Noreen, Brewer and Garrison, 2011, p.556).With its assumed cut-off period of 5 years, it would be possible for any project that had all its cash inflows occurring slightly after the fourth year but within the five year period remaining acceptable. It does not matter that one project has its cash flows occurring earlier on in the life of the project while another has its cash flows coming much later.

In addition, the technique ignores all those cash flows occurring after the chosen payback period (Noreen, Brewer and Garrison, 2011, p.557). This is particularly true in the present project where the last two years have the largest net positive cash flows. Exclusive reliance on the payback period may see these two cash flows completely ignored because they are only important to the point where the project is assumed to have recouped its initial investment.

Lastly, neither does the technique provide objective criteria for assessing the profitability of a project nor does it provide a measure for shareholder wealth maximisation (Noreen, Brewer and Garrison, 2011, p.557). These two weaknesses stem largely from the fact that the technique focuses on the speed within which the initial investment can be recouped as opposed to measuring profitability or maximising shareholder wealth.

Criticisms of NPV

Regarded as the most theoretically sound investment appraisal criterion, the NPV also has two main weaknesses. The first of these is that it does not provide a gauge for profitability (Gitman and Zutter, 2012, p.392). This is easily explained by the fact that any project with a positive NPV should be accepted without much focus on the extent to which the NPV is above zero. Thus, the fictional Wiley project currently under analysis would still have been acceptable even if the NPV was just $2.

Lastly, most people also see the NPV as a complicated method of analysing projects. This is again self explanatory as the concept of discounting is not obvious to most managers without a financial background.

References

Atrill,P. and McLaney,E.,2009.Managment Accounting for Decision Makers.6^th edn.Edinburgh    Gate: Pearson Education.

Gitman, L.J. and Zutter, C.J., 2012.Principles of Managerial Finance.13^th edn.Boston, MA:          Pearson.

John Wiley & Sons Inc.,2006. Annual Report 2016.

Noreen, E.W., Brewer, P.C. and Garrison, R.H., 2011.Managerial Accounting for Managers.2^nd   edn.New York: McGraw-Hill Irwin.

Yahoo Finance 1.,2016. John Wiley & Sons Inc.(JW-A).[online] Available at: <              https://finance.yahoo.com/quote/JW-A/?p=JW-A  >[Accessed 28 August 2016].

Yahoo Finance 2., 2016.U.S Treasury Bonds Rates.[Online] Available at:   <http://finance.yahoo.com/bonds > [Accessed 28 August 2016].

 
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