Application of Investment Appraisal Techniques for Decision Making

This essay discusses the application of investment appraisal techniques for decision making in business. It evaluates the profitability of two projects using net present value and payback period. The advantages and disadvantages of these techniques are also discussed. Non-financial factors that should be considered in decision making are highlighted.

BUSINESS DECISION
MAKING

TABLE OF CONTENTS
REFERENCES...........................................................................................................................8

Decision making is something based on which business is run. The decisions are
taken in respect to the business expansion or further investment proposals. This essay is about
the application of investment appraisal techniques for the purpose of taking decisions on
investment prospects.
Evaluating the investment appraisal techniques for decision making
The two investment appraisal techniques that will be used XYZ plc for evaluating the
profitability of the two project A and project B.
Net present value
It is the capital budgeting technique which takes into account the present value of cash
flow for determining the profitability associated with the project. It is the difference between
the present value of cash inflow and cash outflow (Wang and et.al, 2017). The positive NPV
indicates that the company can proceed with the project and invest in it. On the other hand,
the negative NPV shows that the project is not profitable and feasible for the business.
Project A
Computation of NPV
Year Cash inflows
PV factor
@ 11%
Discounted
cash
inflows
1 28000 0.901 25225.2
2 32000 0.812 25972
3 35000 0.731 25592
4 55000 0.659 36230
5 78000 0.593 46289
Total discounted cash
inflow 159308
Initial investment 100000
NPV (Total
discounted cash
inflows - initial
investment) 59308

Project B
Computation of NPV
Year
Cash
inflows
PV factor
@ 11%
Discounted
cash
inflows
1 31000 0.901 27927.9
2 38000 0.812 30842
3 43000 0.731 31441
4 64000 0.659 42159
5 89000 0.593 52817
Total discounted cash
inflow 185187
Initial investment 120000
NPV (Total discounted
cash inflows - initial
investment) 65187
Analysis and interpretation:
Based on the above, the NPV of both the projects is positive and XYZ plc can invest
into it. But as only one project is to be selected, project B should be selected as the NPV of
project B is £65187 which is higher in comparison to project A, that is, £59308. This
technique is mainly used by businesses for taking investment decisions. This method has
various advantages such as it is easy to use if the real cash inflows and the discount rates are
known. It considers the time value of money which accounts for inflation on the future
profitability. Also, the discounting rate can also be adjusted with the risk prevailing in the
market along with other factors. This technique also considers the earnings throughout the
life of the project which helps in knowing accurate output. This method is feasible in

comparing the similar projects for finding out the feasible option. This method is quite logical
as in this cash flows are not expected to be reinvested as in case of IRR.
On the other hand, it has certain disadvantage as well. While assessing the viability of
the long-term project, there are chances that the cash flows estimated may not be accurate. It
is based on discounting rate and even a slight change in it will lead to accurate results. Also,
there is no such guidelines for calculating it. Short term project with higher NPV may not
boost the earning per share and return on equity and might not work in the favour of the
company’s shareholders.
Payback period
Payback period is used in determining the time it will take to recover the amount
invested in the project (Káposztásová and Vranayová, 2018). Shorter the period better it is for
the company. Also, it will help in taking better and quick decisions.
Project A
Computation of Payback period
Year
Total cash
flow
Cumulative cash
flow
1 28000 28000
2 32000 60000
3 35000 95000
4 55000 150000
5 78000 228000
Payback
period
3 + 0.1
= 3.1 years
Project B
Computation of Payback period
Year
Total cash
flow
Cumulative cash
flow
1 31000 31000
2 38000 69000
3 43000 112000

4 64000 176000
5 89000 265000
Payback
period
3+ 8000/43000
= 3.2years
Analysis and interpretation:
As per the payback period calculated above, the payback period of project A is 3.1
years and that of project B is 3.2 years. Based on this, project A is more feasible as it takes
shorter time for recovering the amount. The longer payback period indicates that the capital is
tied up. It focusses on the liquidity of the company. It is the most reliable technique and also
it is easy to calculate and understand.
In contrast to it, it ignores the timings of the future cash flows while calculating
payback period. Also, it does not consider the cash flow which is produced after the payback
period. It cannot draw any distinction between the projects having same payback period.
Another important point is, it does not consider residual value of the asset at the end of the
project.
The both the above discussed techniques give a different outcome but because of the
advantages provides under NPV method overcomes the advantages and disadvantages of
payback period. Thus, XYZ plc should invest in the project B.
Impact of financial and non-financial factors in decision making
The above discussed techniques come under the financial aspects which is mainly
considered for decision making but there are certain non-financial aspects as well which has
huge influence over the decision making (Roy and Hota, 2017). Some of the important non-
financial factors which XYZ plc should consider are stated below.
 Analysing and identifying the changing market trends and competition.
 Meeting with the all the legislation requirements both current and future,
 Relationship with local communities and suppliers and employees of the organization
which will help in improving the reputation of the business.
 Dealing with the uncertain events such as protecting the intellectual property with
respect to the potential competition.
 Staff morale is essential which helps in recruiting and retaining the employees.
 Resistance to change, e.g., introducing new technology.
 Whether the company will be able to effective manage the service in-house or not.

For instance, while purchasing a new machinery, the environmental impact of its required
to be considered which will affect the reputation of the company as well.
Thus, all these factors should be considered while taking any investment based
decisions as it may have a huge impact over the business cash flow such as incurring
losses or unwanted expenses.

REFERENCES
Books and Journals
Káposztásová, D. and Vranayová, Z., 2018. Decision Analysis Tool for Appropriate Water
Source in Buildings. In Water Resources in Slovakia: Part II (pp. 269-284). Springer,
Cham.
Roy, D. and Hota, D.C., 2017. Role of Non-Financial Factors in Industrial Investment
Decisions: Findings from Survey. Research Bulletin. 43(3). pp.33-48.
Wang, Q. and et.al, 2017. An application of normative decision theory to the valuation of
energy efficiency investments under uncertainty. Automation in Construction. 73.
pp.78-87.