Part I: Evaluation of Investment

 Average rate of return on investment (ARR): Calculated by dividing average annual

profits with the average annual investment. Unlike other capital budgeting techniques,

ARR use accounting profits rather than cash flows. A higher rate means higher

profitability and value for stakeholders. Since ARR for Bangalore location is more than

Mumbai, Garrison Co. should choose to invest in Bangalore

Mumbai Bangalore
Net cash inflows 1,100,000 860,000
Less: Depreciation (250,000) (140,000)
Profit before tax 850,000 720,000
Tax (40%) (340,000) (288,000)
Accounting profit after tax (a) 510,000 432,000
Initial investment / 2 (b) 2,500,000 1,400,000
Average return (a) / (b) 20.40% 30.86%

 Payback period: Refers to the time period (in years) it takes to recover the initial capital

investment. Payback period is 4.90 years for Bangalore and 6.58 for Mumbai which

suggests that investment in Bangalore will be recouped earlier as compared to Mumbai.

Hence, according to payback rule, Bangalore is the appropriate choice.

Mumbai Bangalore
Initial investment (a) 5,000,000 2,800,000
Net cash flows per year (b) 760,000 572,000
Payback period: Years (a) / (b) 6.58 4.90

 Net present value (NPV): NPV method works by discounting the stream of future cash

flows (associated with the investment) at the required rate of return (usually cost of

capital) to determine whether or not the risk adjusted dollar value of cash inflows is

higher or lower than the initial outlay. A positive NPV suggests that the project earns
 return in excess of the company’s cost of capital. Based on NPV, investment in Bangalore

is financially worthwhile because it earns more cash flows as compared to Mumbai.

Mumbai Bangalore
Cash inflows excluding depreciation 1,100,000 860,000
Less: Tax @ 40% (440,000) (344,000)
Add: Tax depreciation allowances (N-1) 100,000 56,000
Net cash flows 760,000 572,000
Cumulative PV factor (N-2) 9.129 9.129
Present value of net cash flows 6,937,695 5,221,528
Less: Initial cash outlay (5,000,000) (2,800,000)
Net present value (NPV) 1,937,695 2,421,528

(N-1) Mumbai Bangalore

Depreciation per year (Initial outlay / useful life) 250,000 140,000
Tax allowance @ 40% 100,000 56,000

(N-2) For 20 years @ 9% [1 - (1+i) / i] (1- (1+ 0.09) -20)/0.09

 Profitability index (PI): PI is a relative measure i.e., the ratio of the present value of net

cash flows to the total initial investment outlay. If PI is more than 1, it suggests that the

NPV is positive whereas PI less than 1 represents negative NPV. This method is normally

used when limited amount of funds has to be rationed among different projects. The PI of

Bangalore is 1.86 which is higher than Mumbai. Hence, investment opportunity with

higher PI is preferable.

Mumbai Bangalore
Present value of net cash flows (a) 6,937,695 5,221,528
Initial investment (b) 5,000,000 2,800,000
Profitability index (a) / (b) 1.39 1.86

 Internal rate of return (IRR): IRR represents the effective rate of return earned on

investment. It is the rate which equates the PV of cash inflows with the PV of cash

outflows i.e., the rate at which NPV is zero. IRR for both projects is more than the

company’s cost of capital (9%). So both projects are desirable. However, if the projects
 are mutually exclusive, then Bangalore should be selected because it offers higher IRR as

compared to Mumbai.

Mumbai Bangalore
Initial investment 5,000,000 2,800,000
Net cash flow 760,000 572,000
Cumulative PV factor at which NPV is zero 6.5789 4.8951

IRR (Using interpolation) 14.116% 19.885%

IRR check working: Mumbai Bangalore

Net cash flows 760,000 572,000
Annuity factor for 20 years @ IRR 6.5791 4.8952
Present value of future cash flows 5,000,103 2,800,056
Initial outlay (5,000,000) (2,800,000)
Net present value (NPV) 103 56

Conclusion and recommendation

Based on the above analysis, the summary of results for each of the capital budgeting

techniques used to evaluate the investment can be presented as follows;

Particulars Mumbai Bangalore

Average rate of return on investment 20.40% 30.86%
Payback period 6.58 4.90
Net present value 1,937,695 2,421,528
Profitability index 1.39 1.86
Internal rate of return 14.116% 19.885%

It is evident from the above table that Bangalore project is better from Mumbai in

almost all aspects i.e., it offers higher profitability, more cash flows and low risk. However,

some techniques such as ARR and payback period ignore the time value of money which

could lead to distorted results. IRR method, on the other hand, provides conflicting results if

projects have multiple negative cash flows or if they are mutually exclusive. Finally,

profitability index can only be used when projects are divisible. NPV is usually considered

the most reliable and superior measure as compared to other capital budgeting techniques.

Therefore, based on the above analysis, Investment in Bangalore is recommended.

 Part II: Other Factors

Since the project involves expansion outside the geographical region, several other

factors are important to consider before making final decision.

 Economic factors such as the effect of exchange rate fluctuation, changes in interest or

tax rates, increase in the price of materials etc.

 Legal factors like country specific financial reporting framework and the degree of

government’s intervention.

 Technological factors such as the introduction of more efficient and advanced toasters

that replace traditional products.

 Political factors including travel bans, quota restrictions and other constraints on import /

export.

 Social factors such as safety policies and concerns about environmental sustainability i.e.,

waste disposal.

 Other factors including the degree of competition in market, availability of close

substitutes, bargaining power of buyers and limits on entry / exit etc.

Part III: HRM Considerations

Cultural differences are one of the most important HRM considerations in this case

i.e., language, norms, customs and values of United States are significantly different from

India. These differences could translate into favouritism (i.e., choice of local brands) leading

towards interdepartmental conflicts and political fights. Another important HRM aspect is the

cost of training and reorganizing. The management can approach this problem by adding an

appropriate risk margin to its cost of capital. Nevertheless, dealing with workforce diversity

requires an organization to implement effective change management strategies that ensure

employee satisfaction and maximize the firm’s value at the same time.
 References

 Brealey, R. A., Myers, S. C., & Marcus, A. J. (2012). Fundamentals of corporate finance.

New York: McGraw-Hill/Irwin

 Moosa, I. A. (2002). International Capital Budgeting. In Foreign Direct Investment (pp.

102-130). Palgrave Macmillan UK.

 Cooper, I. A., & Kaplanis, E. (2000). Partially segmented international capital markets

and international capital budgeting. Journal of International Money and Finance

 Brigham, E. F., & Houston, J. F. (2012). Fundamentals of financial management.

Cengage Learning.