Investment Appraisal
- Created by: Thomas Cebula
- Created on: 02-06-11 09:25
Fullscreen
- Investment Appraisal:
- Investment appraisal means evaluating the profitability or desirability of an investment project.
- This usually undertaken through the use of quantitative techniques that assess the financial feasibility of the project.
- Qualitative methods will also be used when assessing non-financial issues.
- Some businesses, usually those dominated by a a founding entrepreneur will not apply the formal investment appraisal, and use his/her's 'feel' for what may be a successful project.
- Quantitative methods of Investment appraisal will make comparisons between the cash outflows or costs of the project and the expected future cash inflows
- What information is necessary?
- The initial cost of the investment
- The estimated life expectancy
- The residual value of the investment
- The forecasted net returns or net cash flows of the project
- Quantitative Methods of Investment Appraisal:
- 1. Payback Period
- 2. Average rate of return
- 3. Net Present Value
- 4. Internal Rate of Return.
- Forecasting Cash Flows in an uncertain environment.
- Forecasted Net Cash Flow : F.C.I - F.C.O
- These net cash flow figures can then be compared with those of other projects and with initial cost of the investment.
- With long-term investments where forecasts several years ahead have to be made, there will be increased chances of external factors reducing the accuracy of the figures. E.g: Economic Recession and Increase in resource prices.
- 1. Payback Method:
- The Payback period is the length of time it takes for the net cash inflows to pay back the original investment.
- E.G: If project costs $2m/ expected payback is $500,000 per year = 4 years
- Year 0= The time period the investment is made = negative cash flow due to expenditure and represent in ("").
- Why is it important?
- Managers can compare the payback period of a particular project with other alternative projects so as to put them in rank order.
- The Payback Period can be compared with a 'cut-off' time period that the business may have laid down.
- A Business may have borrowed the finance for the investment and a long pay back period will increase interest payments.
- Some managers are 'risk averse'- they want to reduce risk to a minimum so a quick payback reduces uncertainties for these managers.
- Advantages:
- It is quick and easy to calculate.
- The results are easily understood by managers.
- The emphasis on speed of return of cash flows gives the benefit of concentrating on the more accurate short-term forecasts of the projects profitability.
- …
Comments
Report