Page 3: Investing in plant
To grow, organisations need to invest. They face many possible investment choices. Wise investment decision-making involves identifying investment opportunities that offer the best chance of a high return. The buoyant market for sandwiches offers worthwhile investment opportunities. The company has made two significant investments in sandwich manufacture.
1. In 1998 Hazlewood Foods purchased Breadwinner Sandwiches in London, with a production capacity of 1 million sandwiches per week.
2. Recently, Hazlewood Sandwiches has spent £25m to build Manton Wood in Worksop with a weekly production capacity of 3 million sandwiches: it currently produces 2 million. This factory is the world's largest sandwich plant.
In business there are several ways to appraise or evaluate the value of any contemplated investment.
A comparatively straightforward method of investment appraisal is the payback method. This involves calculating the number of years it would take a project (e.g. Manton Wood) to pay back (in cash flows) the original investment outlay.
A second method is to find the Net Present Value (NPV) of a proposal. This takes account of the fact that the repayment of an investment is distorted by inflation over time (prices usually rise over time). It recognises, for example, that a £ possessed now is worth more to a business than a £ to be earned next year and in following years, and for two main reasons: that £'s existence is more certain (next year's £ is less certain to be earned) and its purchasing power is likely to be higher because of price rises in the meantime. This method therefore calculates all cash flows in terms of today's money (NPV) and compares these with the capital to be invested in the project.
A third method, the Accounting Rate of Return (ARR), looks at profits rather than cash flows and measures the rate of return on capital employed - the organisation will have a target figure in mind.
In deciding whether to invest in the project, financial controllers at Hazlewood Sandwiches calculated the likely profits from the new factory, using a profit and loss forecast. A simplified format of this is shown below: