Importance of Capital Appraisal Techniques

The provided document is about the importance of capital appraisal techniques in management. It explains that these techniques are essential for analyzing a company's financial position effectively and making better decisions. The document also highlights the significance of resources being fully utilized in a productive manner through proper capital appraisal. References to various books, journals, and online sources are included to support the discussion.

Accounting and Finance for
Managers

EXECUTIVE SUMMARY
Management is able to take better decisions by assessing financial ratios. It provides
effective result to it whether revenue is generated by it or not. Moreover, investment techniques
also guide managers to assess viability of the project in effectual manner.

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
QUESTION 1...................................................................................................................................1
(A) Computation and justification of financial ratios and non-financial ratios to explain the
performance of the company..................................................................................................1
(B) Analyse best performing company and evaluate reasons why this company would be a
positive investment opportunity.............................................................................................8
(C) Analyse poorly performing company and give recommendations to improve financial
performance............................................................................................................................9
QUESTION 2.................................................................................................................................10
(A) Discuss stages in the capital investment decision-making process and role of investment
appraisal process ..................................................................................................................10
(B) Discuss main methods of investment appraisal with suitable numerical example........12
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................15

INTRODUCTION
The financial information is essential for the company as through this, financial position
may be effectively stated whether firm is earning profit or not. The enclosed report deals with
comparison of three companies namely William Hills plc, Ladybrokes coral group plc and Paddy
Power Betfair public limited plc. The financial ratios make clear that companies are effectively
generating revenue or not (Albelda, 2011). Moreover, investment appraisal techniques are also
useful to assess whether project would be successful or not for the company. Management is able
to take better decisions by evaluating techniques of investment.
QUESTION 1
(A) Computation and justification of financial ratios and non-financial ratios to explain the
performance of the company
WILLIAM HILL PLC
Particulars Formula 2016 2015 2014
Profitability ratio
Gross profit margin Gross profit / net
sales * 100
81.74% 85.27% 88.57%
Net profit margin Net profit / net sales
* 100
11.20% 11.55% 14.45%
Operational ratio
Interest coverage ratio EBIT / Interest
Expense
4.51% 5.47% 5.76%
Net assets turnover ratio Net sales / Average
total assets
0.80% 0.95% 0.81%
Structure ratios
Current ratio Current assets /
Current liabilities
0.71 0.52 0.76
Liquidity ratio Liquid assets / 0.71 0.52 0.76
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Current liabilities
Gearing ratios
Long-term debt 719 370 716
Shareholder’s equity 1226 1216 1160
Debt to equity ratio .58:1 0.30:1 0.62:1
Per employee ratios
Profit per employee Net income/ number
of employees
11 12 15
Operating revenue per
employee
Operating income/
number of
employees
99 102 101
LADBROKES CORAL GROUP PLC
Particulars Formula 2016 2015 2014
Profitability ratio
Gross profit margin Gross profit / net
sales * 100
85.40% 0.00% 0.00%
Net profit margin Net profit / net sales
* 100
-14.15% -3.60% 3.21%
Operational ratio
Interest coverage ratio EBIT / Interest
Expense
-0.19% -0.08% 2.76%
Net assets turnover ratio Net sales / Average
total assets
0.62% 1.36% 1.25%
Structure ratios
Current ratio Current assets / 0.33 0.65 0.59
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Current liabilities
Liquidity ratio Liquid assets /
Current liabilities
0.33 0.65 0.59
Gearing ratios
Long-term debt 750 323 439
Shareholder’s equity 1435 456 392
Debt to equity ratio 0.52:1 0.71:1 1.11:1
Per employee ratios
Profit per employee Net income/ number
of employees
-8 -3 3
Operating revenue per
employee
Operating income/
number of
employees
58 84 84
PADDY POWER BETFAIR PUBLIC LIMITED COMPANY PLC
Particulars Formula 2016 2015 2014
Profitability ratio
Gross profit margin Gross profit / net
sales * 100
76.91% 75.92% 80.97%
Net profit margin Net profit / net sales
* 100
0.79% 15.67% 18.89%
Operational ratio
Interest coverage ratio EBIT / Interest
Expense
2.64% 61.70% 978.34%
Net assets turnover ratio Net sales / Average 0.33% 3.94% 2.22%
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total assets
Structure ratios
Current ratio Current assets /
Current liabilities
0.99 0.82 1.34
Liquidity ratio Liquid assets /
Current liabilities
0.99 0.82 1.34
Gearing ratios
Long-term debt 214 143 0
Shareholder’s equity 4317 51 302
Debt to equity ratio 0.05:1 2.80:1 0.00
Per employee ratios
Profit per employee Net income/ number
of employees
2 25 27
Operating revenue per
employee
Operating income/
number of
employees
199 157 141
Gross profit margin:
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5

6

Profit per employee
Operating revenue per employee
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From the above ratios, it can be interpreted that performance of Paddy Power Betfair
company as current ratio is better than other two companies. The ideal current ratio is 2:1 and
other organisations apart from Paddy Power Betfair is better in three years. The reason behind
this is its Paddy Power Betfair’s CR is 0.99:1 that is closer to the idle and also greather than
Ladbroks and William Hill Plc with CR of 0.33 an 0.71 respectively. It states that Paddy Power
had enough resources available to meet out their short-term business obligations and have sound
working capital management structure and cash management structure so as to retain sufficient
cash resources in the business so that deferral liability to the suppliers can be paid timely.
However, with respect to profitability ratios, it can be seen that in 2016, Ladbrokes Gross
margin is 85.40% above than Paddy Power and William hill with gross margin of 76.91% and
81.74%. It is because of significant increase in their revenue from £1,200m to £1,508m by
25.72% through the delivery of quality services. Despite this, although cost grown up but larger
grown driven in its revenue enable business entity to maximize its gross profit evidenced
stronger performance over other firms.
However, on the other side, excessive sales, general and admin expense, expense on
restructure, merger and acquisition and other operational expenditures incurred by the firm
reported net loss. Ladbrokes plc has lower performance as compared to other companies as net
profit margin is negative which shows that performance is not at all good as expenditures are
more than profits. It has to formulate and implement better strategies so that profit may be
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maximised up too much extent (Burritt, Schaltegger and Zvezdov, 2011). The performance of
William is better with larger net profit margin of 11.20% while Paddy Power and Ladbroks
reported (14.15%) and 0.79% respectively. A robust cost control mechanism employed by
William is the key reason why it had performed better over other companies and achieved a great
success. Moreover, effective use of resource enable firm to drive scale based benefits and
maximize profitability.
The financial ratios are interpreted from the financial statements. But apart from this,
non-financial ratios are also key aspect of organisation as it shows performance of company
which cannot be stated in financial term. Non-financial ratios like staff turnover ratio,
absenteeism ratio are qualitative ratios which are vital for the company. If employees' are not
paid adequate salaries then absenteeism ratio rises up which is not a good sign for organisation as
productivity reduces. Staff turnover ratio is another vital ratio as when employees' constantly
leaves organisation, it adversely impacts as overall productivity reduces which is not good for
the company. As a result, organisation should be able to analyse factors which leads to rise in
employee turnover and then corrective measures be taken to minimise employee turnover ratio.
Customer Loyalty is another qualitative factors, William Hill Plc had a highly satisfied
customer base who believe its brand loyalty. Innovation, outstanding service quality and strong
quality products enable firm to deliver a great experience to the customers and exceed their
requirements and expectations strongly. Its differentiating offerings and focus on customer
desires help business in shaping their experience and build loyal relationship. Thus, on the basis
of it, it can be said that brand loyalty of William Hill Plc is quite high.
The gearing ratio shows that in 2015, William Hill Plc’s had repaid its long-term debt
while shareholder equity grows up resultant declined debt to equity ratio to 0.30:1 shows lesser
fixed financial burden on the business entity. However, in the following year 2016, it grown up
to 0.58 due to more debt borrowing by the company indicates higher leverage in the business
because of more debt use in capital structure. By contrast, Ladbrokes Coral Group’s debt to
equity ratio was 1.11:1 reflect consistent decline to 0.71:1 and 0.52:1 in FY 2015 and FY 2016.
It is because, in the capital structure, equity contributes a major proportion whereas debt is used
comparatively in a less proportion. It is near to the idle ratio of 0.50:1 shows strong capital
composition of debt & investor’s equity and good solvency status. However, in contrast to this,
Paddy power Plc’s gearing ratio reflects high volatility as in 2013, it did not used any debt
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whereas in 2015, it suddenly increased due to repayment of shareholders equity and debt
collection indicates financial burden on the business. Thus, in order to minimize it, again in
2016, managerial team satisfied its financing requirement by issuing more share capital resultant
downward change in debt to equity ratio to 0.05:1. Although, it indicates few interest burden due
to less use of debt, however, at the same time, depending excessively on equity has a drawback
as dividend has no tax shields and also did not benefited the firm with trading on equity. Thus,
from the analysis, it becomes clear that solvency position of Ladbrokes Coral Group is
comparatively good over others.
Ranking
Ranks
William Hill Plc 1st
Paddy Power Betfair 2nd
Ladbrokes Plc 3rd
The rank of three companies can be done by looking at the ratios. As such, first rank is
given to William Hills, second rank is provided to Paddy Power Betfair and last rank is given to
Ladybrokes. The rank is given by analysing financial and non-financial ratios. These indicates
that William Hills is proficient in profitability and efficiency and solvency aspect and other
organisations are behind it. It is justified that efficiency ratios and staff turnover plays important
role in performance.
(B) Analyse best performing company and evaluate reasons why this company would be a
positive investment opportunity
The best performing company is William Hills plc which has consistently increased its
performance in the recent years. By analysing performance which are evaluated with the help of
financial ratios, gross profit margin as well as net profit margin is remarkable than other
companies. It may be said that performance is much better than other organisations. Gross profit
margin is 81% in the year 2016 which is not much deviated than past financial years. In addition
to this, net profit margin is also good and is increasing steadily. The best performance is because
well structured strategies that had led to more profits in the gambling industry (Caglio and
Ditillo, 2012).
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Moreover, other ratios like interest coverage ratio and liquidity ratios are also good. By
analysing interest coverage ratio, it is better as William Hills will be able to make timely interest
payments. Ideal interest coverage ratio is 1.5 or more than that, less than this is not good for the
company as it is unable to meet interest obligations. However, William Hills has more than the
rate of ideal ratio which shows that it is profitable. In addition to this, current as well as quick
ratios are also good as it will be able to meet short-term liabilities which collapses within one
year. As a result, it may be conveyed that the company is best performing one.
The company can be profitable one in investing as William Hills is able to make good
amount of profits as it has good gross as well as net profit margin ratios. The investment is vital
element as without analysing strength of the company, investment may go wrong and company
has to incur huge losses. This financial strength and position of the company is identified by
seeking financial ratios through which financial position of the company may be easily found
out. When financial ratios are interpreted then, financial strength of the organisation may be
analysed in the best possible way (Baños-Caballero, García-Teruel and Martínez-Solano, 2014).
Thus, by analysing financial ratios of William Hills plc, it can be conveyed that it is better
performance and investment can be made in this company. It will provide better and effective
results in the form of better returns on investment. William Hills plc is likely to earn more profits
and may expand its reach to more markets. This may be analysed by looking at gross profit
margin ratio.
(C) Analyse poorly performing company and give recommendations to improve financial
performance
The performance of company should be better so that it may be able to perform well in
the market quite effectively. From the calculated financial ratios, it can be analysed that poor
performance company is Ladybrokes coral group plc. It is not able to perform better as it can be
seen through financial ratios. The effect can be seen as net profit is negative in the financial year
2016 which shows that performance of company is gone poor and as a result, costs are exceeded
than profits. The negative net profit margin shows that income generated by the organisation is
less and expenditures and costs are spent more. It is also known as net loss which Ladybrokes
coral group has incurred. The negative profit should be eradicated in that way so that company
can get back on track.
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The net loss also determines that in indirect expenses and costs are increased and income
generated is less than it and then company incurs net loss. It is recommended that organisation
should implement better control techniques such as cost accounting so that it may be able to
control its expenditures in the best possible way. Cost accounting is effective tool of
management accounting and managers can be able to control the cost in effectual way. Direct
and indirect costs may be controlled by it so that organisation may be able to generate profit so
that it can earn profits and financial position may be strengthened in the most proficient way.
It is also recommended that it may cash flow may be maintained effectively. If cash flow
difficulties arises than expenses cannot be cover and organisation may incur losses. Moreover,
resources should be fully optimised and no spoilage be made (Bromiley, McShane and
Rustambekov, 2015). This will provide company overall reduction in net loss and it may get
back on track with much ease. It is also recommended that organisation should not waste
resources where returns are low. As such, while following these recommendations, Ladybrokes
coral group will be able to make performance better and it will lead to profits to it in the most
proficient way (Cheng, Ioannou and Serafeim, 2014). Moreover, net profit margin is negative in
2016 which is -14.15 %. It shows inefficiency of company as it is not earning profits and costs
may be controlled so that it may earn good profits. It is recommended to control the
expenditures.
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QUESTION 2
(A) Discuss stages in the capital investment decision-making process and role of investment
appraisal process
To: Business manager
From: Investment Analyst
Date: 6th January 2016
Subject: Investment Appraisal
The stages in capital investment decision-making process are as follows :
Identifying business opportunities
The investment decision-making process is vital for the company as if investment is done
in unproductive aspect, then losses are occurred which can be hazardous to organisation. As
such, project in which investment is to be made, it should be identified firstly and if project is
viable then investment decision can be taken by the organisation with much ease.
Project screening
The project screening stage is also important element in decision-making process. The
organisation should be able to define the project that how it will help company for maximising
returns on the same. It is also worth mentioning that if project is not defined then resources
applied may be wasted or money may be blocked unnecessarily. Project screening stage is about
preliminary assessment whether it is possible for the company to implement it or not by
assessing its environmental impact and regulatory regime. It results in categorization from this,
manager become able to determine that whether project can be carried out or not.
Analysing and evaluating investment proposals
Thirdly, after defining the project, next step is to extract benefits out of it. It is essential
as when benefits are analysed then viability of the project may be analysed by the company and
also it provides clarity to it regarding benefits project will give in the future (Fracassi, 2016).
The stage consists of using different capital investment appraisal methods to critically appraise
various projects.
Approving investment proposal
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The next stage is to approve the capital investment when it is analysed that adequate
benefits will be imparted by the project. The management of the company approves the same and
as such, investment is made in the most profitable resources.
Implementing, monitoring and reviewing investments
Approval of the project is made then, project is implemented by the organisation so that
benefits may be extracted out of it. It is essential stage as when implementation is not done
effectively, benefits cannot be attained by it. As such, implementation may be effectively made
by the organisation so that it can enjoy better results from it (Gitman, Juchau and Flanagan,
2015).
Project management is the stage in the capital investment decision as through this, the
requirements to fulfil project in the most effective way. Project management is important in
company as through this, it is able to manage project by performing according to the critical
activities and as a result, project may be profitable one to invest.
In capital investment decision-making process is monitoring of the project so that it may
be profitable to company. If it is found that project is lacking some benefits, then corrective
action may be taken to improve upon effectually (Purce, 2014).
Role of investment opportunities
It plays a crucial role in business success because investment opportunities enable
business to expand their competitive position in the market place and enable company to
outerpform above competitors. It offers business opportunities to drive more return in the
business and maximize their profitability. In despite of this, investment in new technology and
other areas help in diversification and strengthening competitiveness of the business enterprise.
Investment in new markets and other products also expands its market and develop more revenue
stream for the firm that helps in assuring long-run stability.
(B) Discuss main methods of investment appraisal with suitable numerical example
The main methods of investment appraisal are as follows :
1. ARR (Average Rate of Return) -
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ARR is effective technique by which company is able to make profit planning with much
ease. As percentage return can be compared with the targeted margin of profit and as a result, it
is helpful technique to management for investment appraisal. Moreover, it focuses on assessing
profit margin.
Example, ARR is calculated by Average profit / average investment * 100
Year Profit of Project 1 (in €) Project 2 (in €)
1 58000 36000
2 2000 4000
3 4000 8000
Average profit 21333.33 16000
Average investment 107000 66000
ARR 19.9% 24.2%
It may be said that project 2 is more profitable as IRR of it is more in comparison to other
project. Higher IRR, better for the firm.
2. Pay-back period
It determines time duration in which project will recoup its initial investment. With
reference to given projects with initial investment of 180,000, payback period is determined as
follows:
Year Project A Project B
Cumulative cash flows
(A)
Cumulative cash flows
(B)
1 50000 48000 50000 48000
2 68000 57000 118000 105000
3 64500 54500 182500 159500
4 76000 68000 258500 227500
5 92000 82000 350500 309500
Project A = 2 years + (180,000-118,000)/64,500
= 2.96 years
Project B = 3 years + (180,000-159,500)/68,000
= 3.30 year
Findings the results, it becomes clear that project A expected to take a lesser time period
of 2.96 years than project B with payback period of 3.36 years, thus, it can be interpreted that
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first project will quickly cover its initial investment, hence, putting money in project A seems
worthy.
3.. NPV (Net Present Value) -
It is another essential investment technique as it measures the return in monetary terms
which will be generated by the firm within stipulated time. It turns out be effective for the
organisation as it also considers time value of money concept which makes it more meaningful
and useful then other investment techniques available to the organisation (Swanson and
Frederick, 2016).
Example, NPV is calculated by subtracting discounted cash inflows from the initial investment.
Year Project A PV factor @
10%
Discounted
cash flows
Project B Discounted
cash flows
1 50000 0.909 45454.5 48000 43636.4
2 68000 0.826 56198.3 57000 47107.4
3 64500 0.751 48459.8 54500 40946.7
4 76000 0.683 51909 68000 46444.9
5 92000 0.621 57124.8 82000 50915.5
TDCF 259146 229051
II 180000 180000
NPV 79146.5 49050.9
NPV of project B is better than higher NPV is useful for the organisation.
4. IRR (Internal Rate of Return) -
IRR is effective technique of investment appraisal as it measures and assesses average return
which will be generated by the firm from the initial investment. It is helpful for the firm as it
through this it is able to invest in the project which has overall high average return. As such, it is
important technique which can be used for project appraisal (Discounted Cash Flow (DCF)
Techniques: Meaning and Types).
Example, The most profitable project to be selected out of the table.
Year -200000 -120000
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1 120000 72000
2 64000 40000
3 66000 44000
IRR 14% 16%
It may be analysed that IRR of the project B is profitable and as a result, company should
invest in the same as higher return is observed that is 16 %.
CONCLUSION
Hereby it can be concluded that organisation should be able to perform better so that it
may garner more profits which is required to sustain in the market. The financial ratios are
important part of the organisation as through this, it is able to analyse financial position
effectively. This is required and as through this, viability of organisation may be analysed by the
management effectually with much ease. Moreover, it is also important for the management as it
may be able to take effective and better decisions for the company so that it may be profitable.
Moreover, capital appraisal techniques are important so that resources are fully utilised in
productive manner.
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REFERENCES
Books and Journals:
Albelda, E., 2011. The role of management accounting practices as facilitators of the
environmental management: Evidence from EMAS organisations. Sustainability
Accounting, Management and Policy Journal. 2(1). pp.76-100.
Burritt, R. L., Schaltegger, S. and Zvezdov, D., 2011. Carbon management accounting:
explaining practice in leading German companies. Australian Accounting Review, 21(1).
pp.80-98.
Caglio, A. and Ditillo, A., 2012. Opening the black box of management accounting
information exchanges in buyer–supplier relationships. Management Accounting
Research. 23(2). pp.61-78.Parker, L. D., 2012. Qualitative management accounting
research: Assessing deliverables and relevance. Critical perspectives on
accounting. 23(1). pp.54-70
Baños-Caballero, S., García-Teruel, P.J. and Martínez-Solano, P., 2014. Working capital
management, corporate performance, and financial constraints. Journal of Business
Research. 67(3). pp.332-338.
Bromiley, P., McShane, M. and Rustambekov, E., 2015. Enterprise risk management:
Review, critique, and research directions. Long range planning. 48(4). pp.265-276.
Cheng, B., Ioannou, I. and Serafeim, G., 2014. Corporate social responsibility and access to
finance. Strategic Management Journal. 35(1). pp.1-23.
Fracassi, C., 2016. Corporate finance policies and social networks. Management Science.
Gitman, L. J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson
Higher Education AU.
Purce, J., 2014. The impact of corporate strategy on human resource management. New
Perspectives on Human Resource Management (Routledge Revivals). 67.
Swanson, D. L. and Frederick, W. C., 2016. Denial and leadership in business ethics
education. Business ethics: New challenges for business schools and corporate leaders.
pp.222-240.
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Online
Discounted Cash Flow (DCF) Techniques: Meaning and Types, 2017 [Online] Available
Through: <http://www.yourarticlelibrary.com/accounting/cash-flow/discounted-cash-
flow-dcf-techniques-meaning-and-types/62075>
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