Gillette brand which was introduced in 1901 is known for its safety razors. Over the past century the company has made many changes including its merger with Procter and Gamble. Today Gillette is considering the production of a new safety razor.
This project will present the pros and cons of this new razor and review the cost and profits, if any, if this new razor actually goes into production. Gillette has a strong hold on the disposable razor market; therefor, one major consideration is how many existing customers will chose to buy the new razor and how many new customers will the product generate?
Other considerations, in fact, this is the first item of consideration is what method of is ti be used to make the final determination; IRR, NPV, or Payback of cost.
In 1997 Gillette spent 1.5 million dollars on project research and development of this new razor. This 1.5 million is a sunk cost and no matter what happens; new production and sales of the new razor or the rejection of the proposed project, this money will not be recovered. For this reason the sunk cost will not be factored into the final decision.
After determining the IRR, NPV and WCC it has been determined that Gillette should move forward with the production of the new razor. The final numbers show that after the initial investment of only $10,000,000 Gillette will make a profit of over 14 million, even after recovery and payback of its initial investments into the project.
The term capital budgeting is used to describe how managers plan significant outlays on projects that have long-term implications such as the purchase of new equipment and the introduction of new products. (Accounting for Management, 2014) There are five technic used to determine if a project is a “GO” or not.
Following are the capital budgeting techniques: Net Present Value Internal Rate of Return Profitability Index Payback Period
Discounted payback rate
Of these techniques the most commonly used are the following three:
Net Present Value method shows the present value of net cash inflows generated by a project including salvage value, if any, less the initial investment on the project. It is one of the most reliable measures used in capital budgeting because it accounts for time value of money by using discounted cash inflows. (Jan, 2013)
Internal Rate of Return method shows the discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally speaking, the higher a project's internal rate of return, the more desirable it is to undertake the project. (Investopedia, 2014) The IRR method is the preferred method when trying to decide between several projects. IRR offers a simplistic comparison when comparing products from different industries. It shows a percentage of return hence the larger the percentage (no matter which product or industry) this is the project to go with.
Payback method – The payback method is exactly what it sounds like. This method uses the amount of time that it will take to payback the initial investment of capital to determine if a project is worth pursuing. Normally the payback period is expressed in years, only a very small project would be considered in months almost like a personal loan. Large investments typically look into long term investment with a return that is measured in years.
There are several ways to ultimately make the decision of wither or not to go ahead with a proposed project; for the purpose of this project paper the method of NPV will be used. By following the steps listed below and answering each of the questions then using this information to compare and contrast the outcomes, Gillette will determine if the company wants to proceed with the production of a new shaving razor that is to be used by its target audience; the American male.
1. Evaluate the acceptability of an investment project using the net…