Capital Budgeting Essay

Contents
ABSTRACT .................................................................................................................. 2
INTRODUCTION........................................................................................................ 3
BACKGROUND ............................................................................................................. 3
Drilling Company ................................................................................................... 3
Proposal-1 .............................................................................................................. 3
Proposal-2 .............................................................................................................. 3
Project Overview .................................................................................................... 3
CAPITAL BUDGETING ............................................................................................ 4
INVESTMENT APPRAISAL TECHNIQUES........................................................................ 5
1 Net Present Value............................................................................................... 5
2 Accounting Rate of Return ................................................................................. 7
3 Payback Period .................................................................................................. 9
4 Internal Rate of Return .................................................................................... 11
CRITICAL ANALYSIS .................................................................................................. 13
QUALITATIVE FACTORS ............................................................................................. 16
CONCLUSION .......................................................................................................... 17
REFLECTIVE PROJECT ................................................................................................ 18
REFERENCES........................................................................................................... 20
APPENDIXES ............................................................................................................ 21

1

ABSTRACT
In this project we analysed two machines one supplied by National and the other by
Xeng. We evaluated both of them through different investment appraisal techniques to find out which is better for us to purchase. National is a bit expensive as it requires
$20 million, while Xeng requires $15 million. Xeng company also provides free maintenance service to their machine.
We found out that NPV and IRR advised us to select National. However, ARR and
Payback suggested to select Xeng. According to different Authors, NPV and IRR are more accurate than ARR and Payback.

2

INTRODUCTION
Background
Drilling Company
Hamadrill is a Libyan drilling company provides drilling and workover services to the major oil operators in Libya. Hamadrill is going to invest in acquiring a new fixed asset represented in Drilling package (Rig) to participate in a project of drilling number of oil and gas wells. Hamadrill has two shortlisted proposals; one from National USA and the other from Xeng China.
Proposal-1
National package costs $20 million having 10 years life with $5 million salvage value, and excludes any service cost. Hamadrill has an agreement with a service provider to provide the maintenance services at $500,000/annum.
Hamadrill operation costs is $600,000/year. The revenue is $5 million/annum.
Proposal-2
Xeng package costs $15 million having 7 years lifetime with no residual value. It includes the maintenance services at no further expenses. However
Hamadrill operation costs is $500,000/annum.
The revenue is $4 million/year.
Project Overview
The project is mainly to drill a number of oil and gas wells in Sharara

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