Investment Appraisal Techniques Comparison

This assignment compares and contrasts two discounted investment appraisal techniques: Net Present Value (NPV) and Internal Rate of Return (IRR). It explores the strengths and weaknesses of each technique, highlighting their importance in evaluating investment returns and making informed business decisions. The discussion covers the time value of money, assumptions underlying IRR calculations, and the potential for misleading results when comparing mutually exclusive investments.

Anwar RADIM
Anwar RADIM

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Faculty Name Mr. Shahid Wani
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Student Name Anwar RADIM
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Turinitin Class ID 19578115
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Course Master in Business Administration
Date Submitted 09/01/2021
ASSIGNMENT INFORMATION
Full/ Part Assignment Full
Date Assignment Issued 13/12/2020
Date Assignment Due 12/1/2021
Assignment IV by Dr. Vivek Mohan
TO BE FILLED BY THE ASSESSOR
Assessment types Marks Marks
Awarded
Understanding the concepts of financial analysis,
interpretation, and tools of financial decision making
40
Understanding Budgeting process and evaluating
organisational performance and tools
30
Understanding and evaluating the procurement and
utilization of funds
30
Overall Marks 100
Overall Grade

Faculty Name
Summative Feedback by Faculty for further improvement
Assessment Brief/Task
The detailed requirements for this task are as follows:
Scenario:
You are to select a PLC that has a listing on any recognized stock exchange of your choice and agree
this with the module tutor. Once this is done, you are required to answer the following questions:
Assignment Task 1 (40 Marks):
1. Provide a brief introduction of your chosen organisation. 5 Marks
2. Critically examine the importance of various functional areas within organisations, emphasizing

the significance of Finance as a critical functional area within your chosen organisation and
how a strategic integration can be achieved? 10 Marks
3. You are required to look into the financial statements of your chosen organisation for the year
2018-19 and explain the following: 25 Marks
a. Analyze and interpret the profit and loss statement, identify the major expenses &
incomes, compare with previous year, & recommend actions for the upcoming year.
You are also required to compare and interpret the P&L statement in the light of cash
flow statement.
b. Analyze the Balance sheet and critically discuss the financial position of your chosen
organisation and recommend future actions.
c. Explain, Calculate and interpret the following ratios for your chosen organisation for the
years 2018 and 2019:
 Current ratio
 Quick ratio
 Gearing ratio
 Return on capital employed
 Interest cover ratio
 Net profit margin ratio.
Assignment Task 2 (30 marks):
1. Explain the process and significance of budgeting process. Critically evaluate various methods
of budgeting and how they differ from each other? As a Finance Manager, which budgeting
approach would you employ and why? You are also required to examine the impact of
technology on the budgeting process and see how technology can be best used in the process to
enhance and speed up the budgeting process? 15 Marks
2. Explain why it is important for organisations to measure their performance. Discuss the
different types of performance management tools and techniques which can be deployed in

large global companies for evaluating its suitability across a range of business and economic
environments. 15 Marks
Assignment Task 3 (30 marks):
1. Acquisition and utilization of funds are two of the major decisions taken by an organisation
which requires careful analysis. You are required to explain and evaluate various sources of
finance available to a business. Once this is done, you must examine and justify 15% Net Asset
Investment decision taken by your chosen organisation in order to upgrade the technology.
Which sources of finance do you believe would be appropriate for your chosen organisation
and why? 15 marks
2. Considering your organisation’s plans of making capital investments which is the need of the
hour as the organisation is facing a tough competition, the board of directors have approached
you for your expertise in regards to making a capital decision. You must critically evaluate the
investment appraisal techniques you would employ to help your organisation to reach a
decision. You are also required to explain the time value of money and hence compare and
contrast the discounted and non-discounted capital budgeting techniques. 15 Marks
Word count: Approx. 5500 words
Contents
1 TASK 1: Vivo Energy Mauritius Limited Financial Analysis...........................................9
1.1 Introduction.................................................................................................................9
1.2 Functional Areas........................................................................................................10
1.3 Financial Statement Analysis....................................................................................11
1.3.1 Profit and Loss Statement Analysis...................................................................11
1.3.2 Balance Sheet Statement Analysis.....................................................................13
1.3.3 Ratio Analysis....................................................................................................15
2 TASK 2: Budgeting and Organisational Performance Management...............................17

2.1 Budgeting..................................................................................................................17
2.1.1 Budgeting Process..............................................................................................17
2.1.2 Significance of Budgeting..................................................................................18
2.1.3 Methods of Budgeting........................................................................................19
2.1.4 Impact of Technology on Budgeting..................................................................20
2.2 Performance Management.........................................................................................21
3 TASK 3: Capital Budgeting.............................................................................................24
3.1 Question 1: Source of finance...................................................................................24
3.1.1 Equity finance....................................................................................................24
3.1.2 Debt Finance......................................................................................................25
3.1.3 VEML Investment..............................................................................................26
3.2 Question 2: Investment Appraisal Techniques..........................................................26
3.2.1 Non-Discounted Techniques..............................................................................27
3.2.2 Discounted Techniques......................................................................................28
4 References........................................................................................................................30
5 Appendix..........................................................................................................................32

1 TASK 1: Vivo Energy Mauritius Limited Financial Analysis
1.1 Introduction
Vivo Energy Mauritius Limited (VEML) is a public limited company established in 2011.
The company acquired all shell’s operations within the country and is currently responsible
for the distribution and marketing of shell-related products to commercial customers and
retailers within Mauritius (Vivo Energy Mauritius n.d). VEML is part of the Vivo energy
group which is distributed and markets shell-related products across the African continent.
The company’s products are classified into two major category namely retail and
commercial offers. Retail products include shell fuels, lubricants, LPG, and card services.
Under the shell fuel category, the company supplies Shell fuel save diesel and unleaded fuel.
The lubricants supplied by VEML include Shell Helix, Shell Advance, and Shell Rimula. The
third product supplied by the company is liquified petroleum gas (LPG) under the brand
name shell gas. Last but not least, the company provides its customers with various card
services (Vivo Energy Mauritius n.d). The card services option offered by VEML includes
visa card, fleetman card, and Shell card.
Also, the company offers various commercial products. Products supplied to
commercial customers include Shell diesel, Shell oil, shell Rimula, Shell Gadus, Shell Tellus,
and Shell gas. Vivo Energy Mauritius Limited has only been in operation for 8 years and as
of 31st December 2019, the company had 119 employees. The total number of service stations
within the country amounted to 49 in 2019. The company had 49,923 metric tonnes of fuel
and 4,175 metric tonnes of LPG storage (Vivo Energy Mauritius Limited 2020).

1.2 Functional Areas
There are various functional areas within any organisation. The number and size of these
areas vary across organisations with the most common functional areas being Finance,
operations, marketing, and human resource. Each of these areas is important to the successful
running of a company. The operations function ensures that the inputs are translated into
goods and services that are of quality and meet the demand in the market. The marketing
function is another critical function because it ensures that customers are made aware of an
organisation’s products. Also, marketing helps in identifying different customers’ needs
thereby enabling a company to supply products that satisfy customers. The human resource
function is significant to an organisation because it ensures the right talent are hired and
retained. Employees play a major role in the success of a company and hence the importance
of this functional area.
Another critical functional area in an organisation is finance. This area is significant
to an organisation because it manages all the finances of an organisation. The finance
function carries out the planning and budgeting process ensuring the achievement of strategic
goals. The area also a source for finances needed for expansion and day-to-day running of an
organisation. And last but not least, finance provides useful information used by management
in the decision-making process. Therefore, finance is a key functional area within an
organisation.
Strategic integration can be achieved at VEML by integrated the different functional
areas. The company buys, stores, markets and distribute petroleum product. Therefore, by
establishing an integrated model, controls can improve, and efficiency increased thereby
improving its performance. Integrating the operation, marketing, and financing functions will
ensure smooth flow of processes thereby increasing efficiency.

1.3 Financial Statement Analysis
Financial statement analysis looks into the company’s performance through its profit
and loss statement, balance sheet statement, and ratio analysis.
1.3.1 Profit and Loss Statement Analysis
The company profit and loss statement show the company’s profitability during a
period. This statement summarises the company’s incomes and expenses during the financial
year. Table 1 below shows VEML's main expenses and incomes for the fiscal year 2019 and
2018.
Table 1:Major Income and Expenses Analysis
FY2019
% of
sales FY2018
% of
sales
Rs 000
Difference
%
Diff.
Revenue from customers
contract 11,825,133 12,849,184 - 1,024,051 -8%
Cost of sales 10,834,726 91.62% 11,943,911 92.95% - 1,109,185 -9%
Gross profit 990,405 8.38% 905,273 7.05% 85,132 9%
Administration expenses 571,259 4.83% 541,944 4.22% 29,315 5%
Operating profits 444,678 3.76% 397,844 3.10% 46,834 12%
(Source: Vivo Energy Mauritius Annual Reports 2019)
It is evident from Table 1 above that the company’s operating profits increased in
2019 despite a decrease in its revenue in the same year. The company’s revenue decreased by

8% in 2019 compared to the previous. Similarly, the cost of sales decreased to Rs.
10,834,726,000 in 2019 from Rs. 11,943,911,000 (Vivo Energy Mauritius Limited 2020).
The gross profit increased by 9% in 2019 from 2018. The increase in gross profit despite the
increase in revenue is due to a high rate of decrease in the cost of sales. The company’s cost
of sales accounted for 92.95% of sales in 2018 and 91.62% in 2019.
In addition to analysing the profits of the company, the cash flow generated can also
be evaluated. The difference between the P&L profits and the cash flow statement figures is
shown in Figure 1 below. The figure shows an extract of VEML’s cash flow statement.
Figure 1:Statement of cash flows
It is evident from the figure above that the cash generated before changes in working
capital is more than the organisation’s profits before tax because of the several adjustments.
These adjustments include all the non-cash items included in the determination of the
company’s profit. While the P&L statement incorporates non-cash items such as depreciation
in the determination of profits, the cash flow statement excludes such items in the calculation
of cash generated by the company.

Ultimately the company’s operating profits in 2019 increased by 12% despite an
increase in administration costs. Overall, the company’s profitability improved in 2019
compared to 2018. However, the VEML cost of sales is still very high as indicated by the
high proportion of the cost of sales to sales. Therefore, the company should formulate and
implement strategies that will help it to control its cost of sales to improve profitability.
The company’s cost of sales mainly consists of its inventory costs. The cost of
inventories includes in the cost of sales amounted to Rs 10,647,603,000 and Rs
11,741,512,000 in 2019 and 2018 respectively (Vivo Energy Mauritius Limited 2020).
Therefore, I would recommend purchasing its inventory in bulk to reduce inventory costs
(Akeem, 2017). Bulk purchase will enable the organisation to enjoy certain benefits such as
discounts which will significantly reduce the inventory cost thereby reducing the cost of
sales.

1.3.2 Balance Sheet Statement Analysis
The balance sheet is a snapshot of the company’s financial position as at a specific date.
Table 2 below shows the main items on VEML’s balance sheet as of 31st December 2019.
Table 2: Balance Sheet Analysis
2019 2018 Rs '000 Diff % Diff.
Assets Rs '000
Current assets 1,950,099 2,257,352 - 307,253 -13.61%
Non-current assets 1,545,565 1,522,400 23,165 1.52%
Total Assets 3,495,664 3,779,752 - 284,088 -7.52%
Liabilities and Equity
Liabilities
Current liabilities 2,052,786 2,282,739 - 229,953 -10.07%
Non-current liabilities 379,506 439,776 - 60,270 -13.70%
Total liabilities 2,432,292 2,722,515 - 290,223 -10.66%
Equity
Share capital 293,223 293,223 - 0.00%
Retained earnings 770,149 764,014 6,135 0.80%
Total equity 1,063,372 1,057,237 6,135 0.58%
Total equity and liabilities 3,495,664 3,779,752 - 284,088 -7.52%
(Source: Vivo Energy Mauritius Annual Report 2019)
The company’s total assets decreased by 7.52% in 2019 from 2018. This decrease was
caused by the decrease in current assets from Rs. 2,257,352,000 in 2018 to Rs. 1,950,099 in

2019. The decrease in current assets is an indication that the company’s value of liquid assets
was lower in 2019 compared to the previous year.
The company’s liquidity can be further explained by the changes in current liabilities
compared to changes in current assets. The current liabilities decreased by 10.07 indicating a
smaller decrease than the current assets decrease. This analysis indicates that the company’s
working capital decreased in 2019 indicating reduced liquidity in 2019.
Other major items in the balance sheet include long-term liabilities and equity. The
company’s long-term liabilities decreased by 13.7% in 2019 indicating that the company
reduced the use of debt in the current year compared to the previous year. While the company
reduced its use of debt in 2019, its total equity increased by 0.8% due to the increase in
retained earnings. The balance sheet analysis shows that the company’s liquidity level
reduced indicating that its ability to meet its current obligations using current assets declined
in 2019 compared to 2018. On the other, the use of debt reduced indicated a decrease in
financial leverage in 2019.
Therefore, the company should concentrate on improving its liquidity. Liquidity can
be improved through various methods. First, the company could ensure quick payment by
customers through various strategies such as offering a discount for those who pay before the
end of the credit period. Another way of ensuring liquidity would be to reduce current
liabilities by using long-term sources instead of short-term sources of capital to fund the
company’s operations (Kontus & Mihanovic 2019). And last but not least, the organisation
could negotiate for a longer credit period with its suppliers.

1.3.3 Ratio Analysis
In addition to analysing the company’s financial performance using its profit and loss
statement and balance sheet, ratio analysis is another key technique that is used to analyse a
company’s performance. Table 3 below shows different ratios used to evaluate VEML’s
profitability, liquidity, and financial leverage.
Table 3: Ratio Analysis
Formula FY2019 FY2018
Current ratio Current assets/current liabilities 0.95 0.99
Quick ratio
{Current assets - inventory)/current
liabilities 0.65 0.62
Gearing ratio Total liabilities/Total equity 2.29 2.58
Return on capital employed EBIT/ (Total assets - current liabilities) 30.82% 26.58%
Interest cover ratio EBIT/Interest expense 12.92 10.97
Net profit margin Net income/sales 3.28% 2.41%
The current and quick ratios are used to evaluate a company’s liquidity. The current
ratio shows the company’s ability to settle its current liabilities using its current assets. On the
other hand, the quick ratio shows the company’s ability to meet its current obligation using its
most liquid assets. VEML’s current ratio decreased from 0.99 in 2018 to 0.95 in 2019. The
decrease in the current ratio indicates that the liquidity decreased in 2019. However, the quick
ratio increased from 0.62 in 2018 to 0.65 in 2019 indicating an improvement in liquidity. The
quick ratio is a more precise ratio compared to the current ratio and therefore we can
conclude that the company’s liquidity improved slightly in 2019.

The company’s profitability was evaluated using its net profit margin and the return
on capital employed ratio. The net profit margin for VEML increased from 2.4% in 2018 to
3.28% in 2019 indicating that the number of profits generated from sales increased in 2019
compared to 2018. Similarly, the return on capital employed (ROCE) increased from 26.58%
in 2018 to 30.82% in 2019. ROCE shows how efficiently a company is using its capital to
generate returns. A high ROCE shows that returns generated by the company using its capital
employed are high. Based on the net profit margin and ROCE analysis, we can conclude that
the company’s profitability improved in 2019.
The gearing ratio and interest cover ratio shown in table 3 above were used to analyse
the company’s leverage and riskiness. The gearing ratio shows the percentage of the
company’s operations that are funded by debt versus equity. VEML gearing ratio reduced
from 2.52 in 2018 to 2.29 in 2019 indicating a decrease in the use of debt in 2019. Therefore,
we can conclude that the company’s financial leverage reduced in 2019 compared to 2018.
The interest cover ratio increased from 10.97 in 2018 to 12.92 in 2019 indicating an increase
in the number of times the company can use its operating profits to pay its interest. An
increase in the interest cover ratio indicates a reduced risk in default by the company.
Therefore, we can conclude that the company’s risk profile improved in 2019 compared to
2018.
It is apparent from this analysis, that the company’s performance improved in the
current year compared to the previous. The company’s liquidity and financial leverage
improved indicated better financial health in 2019 than in 2018. Also, the profitability ratios
showed improved profitability in 2019 compared to 2018.

2 TASK 2: Budgeting and Organisational Performance Management
2.1 Budgeting
2.1.1 Budgeting Process
The budgeting process is essential in an organisation because it lays down the plans
for an organisation. This process involves preparing the budget, implementing and
monitoring the laid down plans. There are several steps involved in the budget process. The
first step is the identification of organisational goals and objectives (Roestel, 2016). When
identifying the goals and objectives socio-economic and political factors that affect an
organisation must be taken into consideration. Also, the goals should be accompanied by
strategies on how to achieve these goals. Therefore, goals set by an organisation are subject
to its resources.
After identifying goals and objectives, the next step is the preparation of the revenue
and expenditure budget. This process involves forecasting revenues and expenses for the
organisation for a period. This process is usually done in different functional areas within the
organisation and then consolidated to come with the organisation’s revenue and expenditure
budget (Roestel, 2016). In addition to forecasting its revenue and expenses, the organisation
also budgets for capital expenditures. Therefore, the third step is the preparation of the capital
expenditure budget.
The next step in the budgeting process after the preparation of the budget is budget
approval and implementation. The approval of the budget is done by top management who
reviews the budget to determine whether it will be able to help the organisation achieve its
strategic goals. Any corrections on the budget are done before approval by the top
management. Once the budget has been approved, it is then implemented (Roestel, 2016).

The implementation of the budget is continuous as it involves undertaking the action plans
identified in the budget.
The final step in the budgeting process is monitoring and evaluation of the budget.
This process involves setting different budget controls to help measure performance. In
monitoring and evaluation of the budget, the actual performance is compared with the action
plan in the budget and any variances identified. Different corrective actions are then
undertaken to ensure that the goals set in the budget are met.
2.1.2 Significance of Budgeting
Budgeting plays a critical role in ensuring the successful running of an organisation.
Budgeting helps an organisation’s management understand how different activities within an
organisation are likely to change. Management is therefore able to plan for such future events
by identifying different action plans for different scenarios. Budgeting also improves the
coordination of operations within an organisation (Alade, Abiodum & Igbekoyi 2014;
Roestel, 2016). Through a consolidated and integrated budget, managers for various
functional areas are required to work together thereby improving the coordination of the
different activities within an organisation.
Besides, budgeting acts as a motivation for managers. Budget is composed of targets
for different departments within an organisation. Therefore, managers are motivated to work
towards achieving these targets. The budgeting process is important to an organisation
because it is used as a tool for measuring performance. Employees' performance is compared
with budget goals to evaluate their performance towards the achievement of the
organisational goals. Last but not least, budgeting can be used as a control tool (Roestel,
2016). By observing the budgets, an organisation can be able to control its expenditures
thereby controlling its overall costs.

2.1.3 Methods of Budgeting
There are three main methods of budgeting namely incremental budgeting, zero-based
budgeting, and flexible budgeting. The incremental budgeting method involves preparing a
budget based on previous budgets or actuals. In this method, resources are allocated based on
previous period allocations with a small increment. This method is easy to use but not the
most effective method (Roestel, 2016). Incremental budgeting methods assume the changing
circumstances within an organisation.
On the other hand, zero-based budgeting and flexible budgeting method do not base
resource allocation on previous period allocation. In zero-based budgeting, the expenses are
justified every time a budget is prepared. Using this method, the budgeting process starts
from a zero base where expenses for different activities are analyzed afresh and a new budget
is allocated to this activity. On the other hand, flexible budgeting involves adjusting the
budget depending on the changes in the various activities within an organisation (Roestel,
2016). This method is a complex budgeting tool but the most effective budgeting method.
As a finance manager, I would use the flexible budgeting method to budget my
organisation’s activities. This method would my preferred method because it ensures
budgeting efficiency. This method ensures that resource allocation is adjusted as per changes
in activity volume within an organisation. By considering the changes in activities, the
method incorporates the dynamic nature of the market thereby ensuring budget efficiency.
Unlike the incremental budgeting method which encourages spending up to the budget to
ensure more resource allocation in the subsequent period, this method ensures allocation of
resources to areas they need it most. Therefore, the flexible budgeting method would be the
most preferred.

2.1.4 Impact of Technology on Budgeting
Technological advancement has had numerous effects on the various processes within
an organisation and the budgeting process is no exception. Technology has positively
impacted the budgeting process. Because of automation, the time taken in the budgeting
process has been reduced significantly. Automation of different processes within an
organisation enables the organisation to reduce the time spent on doing routine works such as
generating expenditure reports. Using such reports budgets can be easily prepared within
reduced timelines (Alade, Abiodum & Igbekoyi, 2014). Technology has also reduced the
costs involved in the budgeting process. The reduced amount of work as a result of
technological advancement in accounting translates to fewer workforce needed to perform the
budgeting process thereby reducing the cost of budgeting.
In addition to these benefits, technological advanced can be exploited to improve the
budgeting process. Data analytics tools could be used to improve budget efficiency. By
collecting real-time data and analysing, managers will be able to identify activities that have
changed over time and adjust budgets accordingly in good time (Alade, Abiodum &
Igbekoyi, 2014). Also, integrating systems within an organisation can make consolidation of
budgets thereby speeding up the process. Moreover, technology could be used to ensure that
top management can review the budget from anywhere in the world thereby reducing the time
taken to approve budgets. Finding a quorum for budget approval may prove difficult
especially where the top management is extremely busy. This hurdle may delay budget
approval. But if approval meetings can be done remotely, then the budget approval process
will not be delayed.

2.2 Performance Management
Measuring performance is an important component of monitoring any organisation’s
progress. Through measuring an organisation’s performance, an organisation can identify its
areas of weaknesses and improve such areas to ensure optimal results. Also, measuring
performance enables managers to evaluate an organisation’s performance in comparison with
other similar organisations (Dahal, 2018). In other words, measuring organisational
performance ensures that a company is on the right track.
Numerous performance management techniques could be utilised by an organisation
including but not limited to value chain analysis, benchmarking, product life costing, target
costing, and balance scorecard.
Value chain analysis measures an organisational performance by measuring the value-
added on every activity within an organisation. This technique was developed in 1985 by
Michael Porter. The value chain of an organisation describes different activities involved in
producing a product (Dahal, 2018). These activities range from the design of a product, its
production, marketing, and distribution. These activities can be within one particular
organisation or different organisations. Similarly, these activities could be in the same or
different geographical areas. Analysing the cost of these activities against the value added to
the final product helps an organisation measure performance of each activity (Dahal, 2018).
More resources can then be directed towards the most profitable activity in the chain while
fewer resources are directed towards non-profitable activities within the chain.
The second performance management tool that could be used by a global company to
measure its performance is the benchmarking technique. This technique was pioneered in
1979 by Xerox Corporation and it involves comparing an organisation’s performance to a set
measurable parameter within a market (Dahal, 2018). This technique not only focuses on

comparing an organisation's performance with a set of strategic parameters within an industry
but also continually improve an organisation’s processes by exploiting the best practices
against which an organisation’s performance is measured. This is achieved by identifying
gaps between the set of strategic parameters and an organisation’s performance (Dahal,
2018). Action is then taken to fill these gaps by meeting the set parameters or exceeding the
benchmark.
There are four different types of benchmarking namely internal benchmarking,
functional benchmarking, competitive benchmarking, and generic benchmarking. Internal
benchmarking involves comparing the performance of different departments within an
organisation. Competitive benchmarking involves comparing an organisation's performance
with that of similar firms within an industry. Functional benchmarking involves comparing
one functional area performance with that of other functional areas within or outside an
organisation. Last but not least is the generic benchmarking which involves comparing the
performance of all functional areas with set best practices (Dahal, 2018).
The third tool is the balanced scorecard. This tool measures an organisation’s
performance through established performance measures that incorporate both financial and
non-financial perspectives. The non-financial measures are considered leading indicators as
they forecast future performance whereas financial measures report on the result of a historic
decision and are therefore considered lagging indicators (Dahal, 2018).
The four perspectives in a balanced scorecard are customers' perspectives, financial
perspectives, internal business perspectives, and innovation perspectives. The financial
perspective focuses on maximizing the shareholders’ wealth. This perspective measures an
organisation’s performance based on how much returns it delivers to its shareholders. The
second perspective is the customer service perspective which entails how an organisation

attends to its customers’ thereby gaining a competitive advantage over its competitors. This
perspective is a non-financial measure (Dahal, 2018). The internal business perspective is
concerned with the identification of major areas in which an organisation must perform
excellently to achieve its strategic goals. And the last perspective is the innovation
perspective which is more concerned with employees. This perspective measures the extent
to which a company supports its employees to learn and be creative.
The last two performance management tools discussed in this report are the product
life cycle and target costing. Product life cycle costing involves managing all costs involved
in the development of a product. This includes costs related to product design, development,
production, marketing, distribution, and disposal (Dahal, 2018). This type of costing enables
an organisation to measure all relevant costs associated with a product thereby enabling it to
price it accordingly. And by so doing, an organisation will be able to provide value to
customers and gain a competitive advantage in the market.
Unlike product life cycle costing which includes different ways of costing a product, target
costing is a costing method that determines the cost of a product by subtracting an
organisation’s margin from the selling price. This method ensures that costs are managed
adequately early in product life. Since costs are determined based on the supply and demand
of the product in the market, managers focus on controlling their product cost throughout the
product life starting from the design stage (Dahal, 2018). Therefore, an organisation is
capable of measuring its performance by continuously comparing the established target cost
of a product with the actual costs incurred during a product life cycle. Any deviations
identified during such analysis are rectified immediately to ensure that the product cost does
not exceed its market selling price.

3 TASK 3: Capital Budgeting
3.1 Question 1: Source of finance
The various sources of finance available to an organisation can be categorised into
two main categories namely debt and equity finance.
3.1.1 Equity finance
Equity financing involves sourcing for funds by selling ownership of a company. There are
several forms of equity financing including but not limited to selling company stock to
individuals, venture capital, and retained earnings. Funds can be raised by selling an
organisation’s stocks to outsiders. Selling of stock increases the number of shareholders
thereby diluting a company’s earnings per share (Scarborough & Cornwall 2019). As a result,
the cost of equity increases.
Another way, the company could raise funds could be through venture capital. These
are institutions that invest in the various business by buying shares. The advantage of venture
capital in comparison to selling to an individual is this source enables a company to acquire a
large sum of money (Scarborough & Cornwall 2019). Last but not least, the company could
use its retained earnings to fund the investment. When a business makes profits, it is either
pay-out as a dividend or retained in the business for future use. Since retained is dividends
forgone, then it falls under equity financing. This method of financing is the simplest because
it does not involve outsiders (Scarborough & Cornwall 2019). However, in most cases, the
funds in a company’s reserves are not sufficient to finance major projects.
3.1.2 Debt Finance
Debt finance, on the other hand, involves borrowing money from an external party.
Interest is usually paid on such funds and the principal amount must be paid back when the
loan matures. Examples of debt financing include but are not limited to bank loans and

bonds. Bank loans are the most common source of finance (Scarborough & Cornwall 2019).
These loans can either be short-term or long-term. Short-term bank loans are payable within a
year while long-term loans are payable within more than a year. Like any debt financing,
bank loans attract periodic interest payments. Also, portions of the principal amount are paid
periodically.
Unlike bank loans where portions of the principal amount are also paid periodically,
bond principal amounts are paid when the debt matures. When a company sells a bond to
bondholders, it is expected the periodic interest on the bond will be paid until the maturity of
the bond. Once the bond has matured, then the principal amount is also paid back to the
bondholder (Scarborough & Cornwall 2019).
The decision on which source of finance to use depends on a company’s investment
needs as well as its capital structure. A company with a big investment would properly not
fund its investment using retained earnings while a company with a high percentage of the
debt will avoid debt financing at all costs. A highly leveraged company is considered a risky
company and therefore creditors will demand high-interest rates thereby increasing the cost
of debt for such companies.
3.1.3 VEML Investment
VEML is planning on making a 15% net asset investment to improve its technology.
The company’s net asset as of 31st December 2019 was Rs 1,063,372,000 and therefore the
investment would be Rs 159,505,800 as indicated in Table 4 below.
Table 4: Financing Options
Before Investment After Investment
Weight Weight
Total equity 1,063,372 34% 37% 1,222,877.80
Long-term liabilities 2,052,789 66% 63% 2,052,789
Total equity 3,116,161 3,275,666.80

15% Net asset investment 159,505.80
It is clear from Table 4 above that a large percentage of the company’s operations is
currently financed by debt. Therefore, it would not be prudent to increase the debt because it
would increase the company’s risk levels. As such the most appropriate source of finance
would be equity financing and in particular, retained earnings. In 2019, the company retained
Rs 770,149,000 meaning it is capable of financing an investment of Rs 159,505,800 from its
retained earnings. This source of financing is also a less costly and risky method.
3.2 Question 2: Investment Appraisal Techniques
A comprehensive evaluation of an investment decision is a critical process because
investment decisions involve large sums of money. Therefore, before making any investment
it is imperative to evaluate such prospects and establish whether they will help the
organisation achieve its wealth maximization goal. Different techniques are used to appraise
an investment decision. These techniques are broadly classified into major category namely
non-discounted techniques and discounted techniques.
3.2.1 Non-Discounted Techniques
Non-discounted techniques do not discount projected future cash flows thereby does
not consider the time value of money. The time value of money concept recognises that
money received today has a different value in the future. This concept is based on the fact
that money received today can be invested and it will have earned interest in the future
(Olawale, Okubena & Herbst, 2010). For example, if one receives Rs. 1000 today and invest
the same for three months at 8% per annum, the amount received at the end of three months
will be approximately Rs. 1020 indicating that money received today is more valuable than
money received later. Therefore, the non-discounting techniques assume that the value of
money does not change with time.

The two commonly used non-discounting investment appraisal techniques are the
payback period and the accounting rate of return (ARR). The payback period is simply the
number of years it will take a project to break even. It is the number of years it takes for the
projected future cash flow to equal the project’s initial cost. Where the annual cash flows are
equal, the payback period is simply the project's initial outlay divided by the annual projected
cash flows (Olawale, Okubena & Herbst, 2010). However, where the cash flows are uneven
through the project life cycle, then the payback period will be determined by accumulating
the cash flows and establishing the number of years it takes for the project cost to be equal to
the accumulative cash flow.
The payback period is one of the simplest investment appraisal techniques and is
general used in addition to other techniques. This technique is however not reliable where a
project generates large cash flows in the later years of its life because it does not consider all
cash flow. The decision for this technique is to proceed with the project with less payback
period (Olawale, Okubena & Herbst, 2010). Therefore, one may prefer a project with less
payback period and ignore the one with a high payback period, yet it is the profitable one.
The second non-discounting technique is the ARR which is the annual profits of an
investment as the percentage of the investment cost. The annual profits are calculated by
summing up the future cash flows and diving by the number of years the project is expected
to run. The average annual profits are then divided by the investment initial outlay to
determine the ARR (Olawale, Okubena & Herbst, 2010). The ARR is compared to a set
target to determine whether an investment is worth undertaking or not. If the ARR is more
than the target, then the project should be accepted and if the ARR is less than the target, then
the project should be rejected.

Like the payback method, this technique ignores the time value of money making it a
less reliable technique. Moreover, the target against which ARR is compared is set arbitrarily
further making the technique less accurate.
3.2.2 Discounted Techniques
Discounted investment appraisal techniques consider the time value of money in
evaluating a project. Therefore, these techniques involve discounting future cash flow using a
discount rate. There are several discounting investment techniques but for this report, we will
be concentrated on the Net Present Value (NPV) and the Internal Rate of Return (IRR).
The NPV is used to evaluate investment profitability by subtracting the investment
cost from the sum of the investment present value. The future cash flows are discounted to
determine their present value which is then summed up to get the total present value of the
investment. An investment with a positive NPV is therefore considered a profitable project
and should be accepted. On the other hand, a project with a negative NPV is expected to
generate losses and therefore should be rejected (Olawale, Okubena & Herbst, 2010). The
NPV is a more reliable technique as it incorporates all future cash flows and also considers
the time value of money. However, the discount rate used in discounted cash flow is usually
subject to several assumptions thereby making it difficult to rank investments based on NPV.
The IRR is another discounting technique that is used to evaluate returns expected
from an investment. The IRR is the rate at which an investment NPV is zero. In other words,
the rate where the investment breaks even. Therefore, an investment with an IRR less than
the discount rate is rejected while one with an IRR more than the discount rate is accepted
(Olawale, Okubena & Herbst, 2010). Like NPV this, technique considers the time value of
money. Nevertheless, this technique can be misleading when deciding between two mutually
exclusive investments with different initial outlay.

Despite their weaknesses, the discounted investment appraisal technique is considered
more reliable compared to the non-discounted techniques because of the time value of
money. Money today does not have the same value as money tomorrow. And therefore, the
factor must be incorporated in analysing an investment decision.

4 References
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5 Appendix