admt course work

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Table of contents

Contents Page No

Main body

Investment approval should add value to the business

organisation

2

Reasons behind investment appraisal: 2

Disadvantages of conducting inadequate appraisals 3

There are few investment appraisal methods that are industry

standard:

3

Discounted Cash flow (DCF) 4

Reasons investors use discounted cash flow 4

AP Ltd., Project Investment Appraisal 5

Recommendations 8

Selected References 9


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1)

Investment approval should add value to the business organisation

To assist investment manager behind capital allocation for organisations to make better

decisions making on acquiring and disposing of assets.

The main purpose to operate a business is to maximise shareholders wealth. The time

managers are making decisions involving capital investments, the decisions must be

consistent following the objectives of the business.

Key Takeaways

Investment Appraisal

(IA) Definition,Benefits of using IA

Definition of Investment Appraisal: Investment appraisal are conducted to check whether

it is worthwhile to make an investment. If investment involves a large initial cost

followed by later receipt of cash.

Example of an investment appraisal: An organisation could invest in marketing campaign

which might lead the venture to an increase in business growth over the following years.

Reasons behind investment appraisal:Risk management as investment involves dealing with risks

Firms can choose alternative investments through identifying investment options andchoose the best options. Cash and other resources are invested in the most profitable

ways.

Reasons for investment appraisal includes long term decision making by accepting or

rejecting decision making and ranking/mutually exclusive decision making.

Project budgets become more realistic as project budgets can be established.

To eliminate or reduce the risks, risks arising from the investment are considered in astandard investment appraisal.

As capital spending can differ from a day to day revenue spending cause it involves huge

expenditure and the return from a capital expenditure can come back over a long periodof time periods. These are good reasons any proposed capital spending should be

correctly appraised.

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Key Takeaways

Disadvantages of

conducting inadequateappraisals

Disadvantages of conducting inadequate appraisals:

If investment appraisal was done properly then resources ( ie: cash ) can be invested on

optional or unnecessary projects.

Subjective and unfair decisions may be made.

Time, is the essential feature of a good investment decision. Investment in a businessinvolves making an outlay of some of economic value, usually cash profit. This also leads

to long term economic benefits to the investment. The outlay is usually a large amount

and the benefits as series of small amount over a reasonable protected interval.

Considering all the benefits of Investment appraisal, it is clear that Investment Appraisal

should add values to the business to make it more profitable.

Key Takeaways

Investment Appraisal

Methods

There are few investment appraisal methods that are industry standard:

Net Present Value (NPV)

Internal Rate of Return Technique (IRR)Payback method Technique (PB)

Accounting Rate of Return Technique (ARR)Profitable Index (PI)

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Discounted Cash flow (DCF):

Net Present Value (NPV)Internal Rate of Return (IRR)

Key Takeaways

Discounted Cash Flow

(DCF)

As listed above, Discounted Cash flow (DCF) includesNet Present Value (NPV)

Internal Rate of Return (IRR)

Reasons investors use discounted cash flow:

Money has a time value. As the money which will come in future has a present value

because the investors have to borrow it to pay. In business most of the time, the future theinvestor look to the greater the risks are. It will have to spot on to estimate the future

return of a present investment. The risk is things can change and this is the reason

discounted cash flow use discounting to reduce the concerns.

Example is, suppose we expect to receive 200 in one years time and use a discount rate

of 10 percent. If we put 180 deposit at 10 per cent for one year, it will be 200. In otherword, the present value for 200 is 180.

Key Takeaways

Net Present Value(NPV) Discounted

Cash flow

Net Present Value (NPV):

Net Present Value considers three things

Interest lost, risk, effects of inflation.

For example if Machine Costs: 100, life for the machine is 3 years, forecasts cash flowsare

Year1=40, Year2=70, Year3=50, to calculate NPV the investment managers can

decide the payout as well, which can be 100, discount rate=10%.

Year 1 40

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Year 2 70

Year 3 50

Total cash flow 160

- Payout (100)

--------------------------------------------------------------------

Net Value in 3 Years 60

Year 0 -100

Year 1

Year 2

Year 3

2) AP Ltd.,

NPV at 20%,

= - C0+[Cn*Ani]

= -449,400+[100,000*A 10 20]

= -449,400+100,000* 4.192 { from the Annuity Table }= -449,400+ 419,200

= - 30,200

NPV at 14%

= - C0+[Cn*Ani]

= -449,400+[100,000*A10 14]= -449,400+[100,000*5.216]

= -449,400+521,600

= 72,200

B = 72,200

We know that at IRR, the discount rate that makes NPV=0So, Initial Investment will be,

449,400-72,200

=377,200

So, IRR = 14% +{ NPV at 14% / (NPV at 14% - NPV at 16%)} * (16%-14%)

= 14%+ { 72,200/(72,200-33,900)}*2= 14%+3.77%

= 18%

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A = 18%

[ C ]

At IRR, the discount rate that makesNPV=0,

NPV = 0

NPV at 20% = 0-C0+[C1*A10 20] = 0

C0 = C1*4.192

= 70,000*4.192= 293,400

C0 = Initial InvestmentC1 = Annual Net Cash flow

C = 293,400

[D]

NPV at 14%,-293,440+[70,000 * A 10 14]

= -293,440+365,120

= -71,680

D = 71,680

[E]

At IRR, the discount rate that makes, at 14%,So, -C0+[C1*A 10 14] = 0

So, C0 = C1* A 10 14

So, C1 = 200000 / A 10 14So, C1 = 200000 / 5.216

So, C1 = 38,343.56

So, C1 = 38344

E = 38,344

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[F]

NPV at F,

-C0+[Cn * Anf] = 39000

Accumulated Discounting Factor= NPV +Initial Investment / NCF

= (35,624 + 200,000)/ 38,343

=6.145= 10% { * From the discount factor table }

F = 10%

[G]NPV at 12% is 3900039000= -C0+[Cn * A 10 12]

Cn*5.650=-300,000+39000

Cn = 339,000/5.650Cn = 60,000

G = 60,000

[H]

As it is given forProject 4, NPV at 12% = 39,000

As to calculate H, we basically calculating the InternalRate of Return(IRR) where the discount rate is zero and

the relation between the NPV and IRR methods, the NPV

would be the summation of the net cash flow. It isbasically a linear interpolation where NPV=0.

We can take a higher cost of capital,

If we take 20% as cost of capital,

NPV at 20%,= -C0+Cn* A 10 20

= -300,000+60,000*A 10 20

= -300,000+60,000*4.192= -48,480

So, IRR will be,

C0 = Initial Investment

Cn = Annual Net Cash flowA 10 20 is Annuity from theAnnuity table for 10 years

period and 20% discount

rate

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= )1 22 0(%2 0%1 2

%1 2

N P V a t N P V a t

N P V a t

= 12% + 60,000 / ( 60,000-(-48,480)) * 8

= 12% + 4.42%

= 16%

H = 16%

Project 1,2,3,4 with their initial investments, cost of capital, internal rate of return

and their associated annual net cash flow and net present values.

Project Annual Net

Cash flow

Initial

Investment

Cost of

Capital

IRR NPV

1 100,000 449,400 14% 18% 72,200

2 70,000 293,400 14% 20% 71,6803 38,344 200,000 10% 14% 35,624

4 60,000 300,000 12% 16% 39,000

Recommendations:

So far, we were looking at different methods of investment appraisals for evaluating

investment opportunities. As investment process can be seen as a series of 6 steps, each

needed careful calculations and considerations involving Determine the availability ofinvestment funds, identify the most profitable project, define and classify the appropriate

projects, evaluate the best project, monitor and control the taken project(s).

Availability of the funds: compare to project 1, 3, and 4 it can be seen that the initial

investments on project are sitting in the middle which can be good news for AP Ltd.

As net present value determines the present value for the money which is investment forfuture return and compare to project 3 and project 4, for project 2, NPV 71,680, is

better.

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Annuity Table

This represents 1 at a 1% 30% percentage for 1 10 yearsUse the table to find the appropriate multiplier to use in your NPV calculation

Year 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.9092 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.7363 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.4874 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170

5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.7916 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.3557 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.8688 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.3359 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759

10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145

11% 12% 13% 14% 15% 16% 17% 18% 19% 20%1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.8332 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528

3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.1064 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.5895 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.9916 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.3267 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.6058 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.8379 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031

10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192

21% 22% 23% 24% 25% 26% 27% 28% 29% 30%

1 0.826 0.820 0.813 0.806 0.800 0.794 0.787 0.781 0.775 0.7692 1.509 1.492 1.474 1.457 1.440 1.424 1.407 1.392 1.376 1.3613 2.074 2.042 2.011 1.981 1.952 1.923 1.896 1.868 1.842 1.8164 2.540 2.494 2.448 2.404 2.362 2.320 2.280 2.241 2.203 2.1665 2.926 2.864 2.803 2.745 2.689 2.635 2.583 2.532 2.483 2.4366 3.245 3.167 3.092 3.020 2.951 2.885 2.821 2.759 2.700 2.6437 3.508 3.416 3.327 3.242 3.161 3.083 3.009 2.937 2.868 2.8028 3.726 3.619 3.518 3.421 3.329 3.241 3.156 3.076 2.999 2.925

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9 3.905 3.786 3.673 3.566 3.463 3.366 3.273 3.184 3.100 3.01910 4.054 3.923 3.799 3.682 3.571 3.465 3.364 3.269 3.178 3.092

Selected References:

The Intelligent Investor, Graham, B, Practical Counsel, 1997

http://goliath.ecnext.com/coms2/gi_0199-5221627/Investment-appraisal-Checklist-

181.html

http://www.businesslink.gov.uk/bdotg/action/detail?r.s=sc&r.l1=1073858790&r.lc=en&r.l3=1081822141&r.l2=1073858944&r.i=108182220

6&type=RESOURCES&itemId=1081822742&r.t=RESOURCES

Financial Management for decision makers, Artill, P., FT Prentice Hall 5 th Edition 2000

Capital Investment Decision-Making (Advanced Management Accounting & Finance),Northcott, D., Cengage Lrng Business Press, 1992

The Financial Times Guide to Investing,Arnold G., FT Prentice Hall - 2nd Edition, 2009

Effective Financial Management - Creating Success series, Finch, B., Kogan Page Ltd ,

2010

The Fundamentals of Investment Appraisal (Paperback), Lumby S., Jones C., Thomson

Learning, 1991

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http://goliath.ecnext.com/coms2/gi_0199-5221627/Investment-appraisal-Checklist-181.htmlhttp://goliath.ecnext.com/coms2/gi_0199-5221627/Investment-appraisal-Checklist-181.htmlhttp://www.businesslink.gov.uk/bdotg/action/detail?r.s=sc&r.l1=1073858790&r.lc=en&r.l3=1081822141&r.l2=1073858944&r.i=1081822206&type=RESOURCES&itemId=1081822742&r.t=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?r.s=sc&r.l1=1073858790&r.lc=en&r.l3=1081822141&r.l2=1073858944&r.i=1081822206&type=RESOURCES&itemId=1081822742&r.t=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?r.s=sc&r.l1=1073858790&r.lc=en&r.l3=1081822141&r.l2=1073858944&r.i=1081822206&type=RESOURCES&itemId=1081822742&r.t=RESOURCEShttp://www.paperbackswap.com/book/browser.php?p=Cengage+Lrng+Business+Presshttp://www.pearsoned.co.uk/Bookshop/Results.asp?iCurPage=1&Type=1&Author=G.+Arnold&Download=1&SearchTerm=G.+Arnoldhttp://www.pearsoned.co.uk/Bookshop/Results.asp?iCurPage=1&Type=1&Author=G.+Arnold&Download=1&SearchTerm=G.+Arnoldhttp://www.amazon.co.uk/exec/obidos/search-handle-url/ref=ntt_athr_dp_sr_1?_encoding=UTF8&search-type=ss&index=books-uk&field-author=Stephen%20Lumbyhttp://www.amazon.co.uk/exec/obidos/search-handle-url/ref=ntt_athr_dp_sr_2?_encoding=UTF8&search-type=ss&index=books-uk&field-author=Chris%20Joneshttp://goliath.ecnext.com/coms2/gi_0199-5221627/Investment-appraisal-Checklist-181.htmlhttp://goliath.ecnext.com/coms2/gi_0199-5221627/Investment-appraisal-Checklist-181.htmlhttp://www.businesslink.gov.uk/bdotg/action/detail?r.s=sc&r.l1=1073858790&r.lc=en&r.l3=1081822141&r.l2=1073858944&r.i=1081822206&type=RESOURCES&itemId=1081822742&r.t=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?r.s=sc&r.l1=1073858790&r.lc=en&r.l3=1081822141&r.l2=1073858944&r.i=1081822206&type=RESOURCES&itemId=1081822742&r.t=RESOURCEShttp://www.businesslink.gov.uk/bdotg/action/detail?r.s=sc&r.l1=1073858790&r.lc=en&r.l3=1081822141&r.l2=1073858944&r.i=1081822206&type=RESOURCES&itemId=1081822742&r.t=RESOURCEShttp://www.paperbackswap.com/book/browser.php?p=Cengage+Lrng+Business+Presshttp://www.pearsoned.co.uk/Bookshop/Results.asp?iCurPage=1&Type=1&Author=G.+Arnold&Download=1&SearchTerm=G.+Arnoldhttp://www.amazon.co.uk/exec/obidos/search-handle-url/ref=ntt_athr_dp_sr_1?_encoding=UTF8&search-type=ss&index=books-uk&field-author=Stephen%20Lumbyhttp://www.amazon.co.uk/exec/obidos/search-handle-url/ref=ntt_athr_dp_sr_2?_encoding=UTF8&search-type=ss&index=books-uk&field-author=Chris%20Jones

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