Investment Appraisal Techniques

The assignment presents a collection of research papers and online resources focusing on investment appraisal techniques. It delves into topics such as capital budgeting, cash flow analysis, profitability assessment, working capital management, and the impact of different investment strategies. The provided materials explore diverse aspects of investment decision-making, encompassing theoretical frameworks and practical applications.

BUSINESS FINANCE

Table of Contents
INTRODUCTION...........................................................................................................................1
PART 1............................................................................................................................................1
1...................................................................................................................................................1
2...................................................................................................................................................3
3...................................................................................................................................................4
PART 2............................................................................................................................................5
1...................................................................................................................................................5
2...................................................................................................................................................6
3...................................................................................................................................................7
CONCLUSION................................................................................................................................8
REFERENCES................................................................................................................................9

INTRODUCTION
Finance is an essential part to run business and smooth flow of operations. . Management
of funds, raising cash inflow, investments are necessary activities which support organisation in
its growth (Scott, Scott and Cacho, 2013). Business finance is the concept which assists in
analysing the actual business performance of the enterprise so that individual can take
appropriate decisions to generate more profits. The present report is based on scenario of
EyeWatering Inc and Wild Frontier Builders Ltd (“WFB”). It will focus on difference between
profitability and cash flow. Consequences of shortage of cash in the entity and appropriate
solution for resolving this issue will be illustrated in this report. Further, the stages of capital
budgeting process and capital investment appraisal methods will be discussed in this report.
PART 1
1.
Wild Frontier Builder Ltd (WFB) is the organisation of London which is working upon
property maintenance field. It has employed approx. 20 workers who are independent. . Neil
Geezer is the leading firm which manages the operations of WFB. Last year, it has earned an
adequate amount of profit. But, due to over-drafted bank account for nine years, now Neil is
planning to invest more money in it. It has owned several thousand pounds in a building project
but now he is struggling to meet the invoice from own contractor. Large number of stock of
plumbing and building supplies are kept in warehouse (Oladipupo and Okafor, 2013).
Cash flow and profit are two major parts and equally important to run business
significantly. Chief Financial officer needs to keep track of both and need to evaluate the
outcome from time to time, otherwise it can create financial problem in the enterprise. Cash flow
is the movement of currency within the firm. Whereas, profit is the net income of the company
after deducting the all expenses. Cash flow is subdivided into two sections; inflow and outflow.
It is very necessary to look upon the overall cash at the end of financial year. Inflow is generated
by sales of goods, investments, sales of assets etc (Desogus and et.al, 2013). It goes out by
purchasing machineries, principal debt service and direct expenses such as salaries etc. Profit is
the final net income of firm which is gained after paid out all disbursement.
Another difference in cash flow and profit is that forecasting of cash flow can be done by
mapping out the fluctuation of currency in the firm. But Chief Financial Officer cannot assume
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net profit after certain time period. Forecasting can help to know the time duration when
enterprise is needed cash in hand but if some sudden consequences occur in the workplace such
as increment in tax rates, no payment from buyers etc. (Denis, Denis and Walker, 2015). Then, it
may affect the profit of the company. As if an organisation such as WFB is running operations
on cash basis then Chief Financial Officer can have a good idea of cash flow but assumption of
generation of actual profit is very difficult.
Both cash flow and profit are expresses for the company in a broad way. According to
the case study, WFB has invested thousands of Pound in building project for Vulture Estates and
Weasel Properties with their monthly contract payments. As due to large stock, cash in hand has
fallen down to a great extent. It has created problem in the WFB because other operations cannot
be without sufficient availability of cash. It was on the basis of fact that it is a good investment
but contractors did not pay on invoice on time. Even it was reluctant to get payment from
customers or buyers. It can create a problem because firm has to pay out to suppliers of stock of
plumbing and building suppliers, so cash outflow was in access but inflow has come down
(Mostafa and Dixon, 2013). It will reflect the cash flow statement and profit of the organisation.
It creates the problem of cash flow in the organisation. It is the major consequence of cash flow
problem in the entity. Though, sales are good but inflow of cash can affect the overall business
to great extent. Apart from this, late payment or non-payment, familiar issues, declining sales,
increasing expenses are reason of cash flow problems.
The profit is expressed in the WFB’s accounts. To sustain in the corporate market for
longer period it is necessary to earn continuous profit. Many times as in the case of WFB cash
outflow was increasing due to large amount of purchase of stock and materials but payment did
not get on time. It may not immediately apparent as a problem in WFB but it increased
production cost of the firm. Thus, profit get down to great extent. It is very necessary to
understand the relevant cost data. Business financial statements can get reflect by additional
expenses and reducing inflow. It will impact on the profit and loss account of the organisation
(Hartzell, Sun and Titman, 2014).
Cash flow expressed in the cash flow statement of WFB and profit impacts the income
statement of the organisation.
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2.
Working capital management is strategy of the organisations to manage its accounts.
The major two components come under this are: current assets and liabilities. To run business
significantly, it is very important to achieve proper balance between liability and assets. Excess
liability can harm the economic position of the enterprise. As in the case of Wild Frontier
Builders Ltd due to investment in building project it has purchased large amount of invoice,
stock of plumbing and building supplies materials. Due to this its assets has been raised to great
extent but due to payment was not on time so it creates burden on the WFB and also increases
liability. Henceforth, it has to pay to suppliers but customers were not willing to pay now. It has
affected the current economic position of the organisation (Suhonen and Okkonen, 2013).
Financial health of the firm can be analysed by calculating the working capital ratio.
Capital ratio = Current assets / current liability
Gross working capital = Stock + Debtors + Assets + Cash in hand
Its output is the indicator of company's financial health.
As inventory management is the main element of working capital management. WFB
needs to look upon that before investing much amount. It reflects the current situation of the
cited firm. It is required to make balance between sufficient inventory and needed one. It is
essential to avoid unnecessary stock. As WFB has purchased large amount of building material
so it has to keep this on warehouse and at present it was of no use for the cited firm.
Cash budgeting is the method which is useful to minimise the cash flow problem and
managing working capital in the organisation. They are the techniques that estimate the
requirement of cash in near future in the cited firm (Robinson and Sensoy, 2013). It includes
receipts and payments of all activities. For managing cash it is essential to make balance between
excess and shortage of currency in the organisation. Speed up collection from customers can
support in managing cash and reducing the cash flow issue in the entity.
Inventory management is another method which is great application of working capital
management. Excess stock and unnecessary inventory in the organisation can increase burden of
the firm, by this way production cost of the entity can get increased (Arráiz, Meléndez and
Stucchi, 2014). EOQ (Electronic Order Quantity) is the great model which support in managing
inventories in the corporation. It looks upon the necessary aspects cost of ordering, carrying cost,
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purchase price and annual sales. With the help of his method enterprise can manage working
capital easily ad can enhance its profit margin.
3.
Wild Frontier Builder Ltd now needs to take immediate action for improving the
company’s
Working capital management. According to the given scenario, it is found that WFB is
not getting timely payment from customers. However, it has to pay for purchased material to
suppliers. Slow paying invoice is the common problem in most of the organisation (Bronzo and
et.al, 2013). For minimising or avoiding this issue from the workplace, WFB should clients’
incentives or special discounts for fast paying. It can offer 2%n discount if person pays within 10
days. By this way customer will pay on time. Thus, it will enhance cash inflow in the cited firm,
by this way WFB will be able to pay timely to its suppliers. It will increase worthiness of the
enterprise and will help in managing cash in the organisation well.
Excess inventory is an another problem, WFB has stored most of its building material in
the warehouse so to improve its current situation, WFB needs to fine-tune to its stocks so that it
can be sold within a short time period. Chief Financial Officer is required to monitor the
inventories properly so that it can be managed effectively (Dichev and Tang, 2014). It will
enhance the worth and assets of the firm in positive direction.
WFB is required to implement proper investment appraisals techniques. With the use of
NPV and ARR it will be able to identify the most suitable project of investment. It will support
to know in which project it can gain maximum profit, apart from this by selecting investment
appraisals methods, enterprise will be able to recover its spent amount soon. So it will help in
managing working capital in effective manner (Palacín-Sánchez, Ramírez-Herrera and Di Pietro,
2013).
By investigating the benefits of e-procurements, WFB will be able to reduce its buying
cost of raw materials. It is an electronic sourcing tool which can help to manage the working
capital in effective manner. E-auction will help to negotiate with suppliers thus, building material
can be made available at lower rate. Which will enhance profit and assets of the cited firm
(Bøhren, and Josefsen, 2013).
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PART 2
1.
EyeWatering Inc is a video game designing organisation, its products are on high
demand. Currently firm is doing well and now need to invest in other projects too for expansion.
Its main objective is now to expand current funding structure. It has two projects, now
investment bank requires cost of funding in both of the projects (Ding, Guariglia and Knight
2013). So, the management team can take final decision on which project will be worthwhile for
the organisation.
Capital budgeting is the process which determines whether expenditure is having positive
interest in the company or not. Stages of capital budgeting process are as following: Identify and evaluate potential opportunities: It is the first stage in which firm is required
to identify and evaluate the most suitable beneficial project. As EyeWatering Inc has two
projects first is call of the assassins part XXIII, in which it has to invest at least $10
million for developing and executive a new game (Van den Bogaerd and Aerts, 2015). It
is to be expected that it will require at least 2-3 years for establishing properly. Whereas,
in second project, $6 million over 1-2 years investment is needed. It has longer shelf life.
So, in second one the company has good opportunities to gain profit. Estimate operating and implementing cost: In the second phase, chief financial officer of
cited firm is required to operating cost attached in the investment. In project 1; enterprise
will need skilled employees, high machineries so operating cost in high but in second
comparatively cost is low. Estimate cash flow or benefit: In this step, financial officer of EyeWatering Inc needs to
forecast the cash flow for the same. As it will have to review the previous data which has
same records, it will have to identify the whether they were successful or not (Mukherjee
and et.al, 2013). It will help to know the actual benefit of investment in particular project. Assess risk: There are many risk attached such as people do not like game design, lack of
sales, high production cost, short time life cycle etc. Once management team has evaluate
the risk then it will be easy for them to take appropriate decision.
 Implement: It is the last stage of capital budgeting in which company take final decision
of selection of project and move forward with it. Financial officer will need to prepare a
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implementation plan which include cash require, time scale, outcome etc (Tang and
Chang, 2012).
There are several investment appraisal methods, description of them are as following:
 NPV: It is the great technique which support to identify the most suitable project for the
investment so that cited firm can get maximum return and recover its invested amount
soon. It defines the net present value of future cash receipts. It is beneficial because it
gives time value of money. Profitability and risk assessment are easily identified by using
this technique (Andor, Mohanty and Toth, 2015.).
 Payback period (PBP): It is another capital budgeting method which helps to identify
that in which project firm will be able to recover its investment soon. It is simple process
then other methods. It focuses on risk and determines that how quickly invested amount
can be recovered (Basic investment appraisal techniques, 2012).
 Accounting rate of return (ARR): It is another capital budgeting method, it calculates
the return on investment.
ARR = Average return / average investment
The major benefit of using this method is that it gives percentage return so that one can
compare it with target return. ARR focuses on overall or entire profitability of the chosen
project. It is beneficial in measuring the current performance of the organisation.
2.
Net present value: Advantage: The major benefits of using this capital investment appraisals technique is
that it helps to identify the future worth by comparing it from current value of money.
This concept gives priorities to profitability and risk attached with the projects. It is quite
simple process so staff can easily calculate it and can get a result quickly. NPV method
supports to maximize the value of firm to great extent. NPV emphasizes on calculating
the amount of return which firm can get in every year. It increases the value of the cited
firm and supports in giving the higher profit to the enterprise.
 Disadvantage: For calculating the value of NPV, firm has to estimate each year cash
transactions. By this way simple calculation become complex for getting the accurate
results. Company has to use numerous tables, interest rates for each year (Investment
appraisal techniques, 2016). This method involves lots of assumptions. As interest rate,
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amount in future etc. need to be estimated by the manager. Forecasting increases the risk
if it gets wrong. It is very difficult to assume the discounting rate for future.
Payback period: Advantage: The simple procedure and technique is the major benefit of this method. It is
easily understandable and calculating technique. Since, it focuses more upon risk and
clearly determines that longer period project has huge risk so the investment which gives
immediate and returns on shorter period will be the best suitable. So risk of failure gets
reduced to great extent. The addition advantage of this concept is that calculation of
expenditures. So that firm will be able to manage its cash flow easily and will be able to
prepare effective plan for the same (Desogus and et.al, 2013). Disadvantage: Its major drawback of PBP is that manager can not recognize the time
value of money. It pays more focus on liquidity but ignores on profit side of the
investment. Payback period does not take into consideration time value of money and
estimates the duration in which initial amount is recovered.
Average Rate of Return: Advantage: The method takes into consideration the accounting information so as to
estimate annual return of the expected investment. It is simply understandable technique
and easy to calculate. It major focus on profitability of the project so enterprise can get to
know whether investment will be worthwhile or not. It supports to identify current
performance of the cited firm.
 Disadvantage: It does not considers the time value of money and cost of capital for
calculation purpose. It totally avoids the important aspect which is cash flow (Investment
appraisal techniques, 2016).
3.
Net present value method is regarded as the most suitable method for evaluating proposal
of EyeWatering Inc. It helps in estimating real present value of the project by accounting for
timvalue of money and cost of capital. In project 1 which is call of assassins part XXIII, in this
EyeWatering Inc is required to invest high amount which is $10 million for the development of
new game and its execution. Apart from this time scale of development is around 2-3 year. It is
estimation that this new video game will take time of at least 2-4 year for establishment after
launching. It is a long duration so it may be possible that customer change their mind or any
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other competitor launch new attractive game. So, risk is too high. By this way it can be said that
this investment will not give such good return to the organisation. With the help of NPV
calculation, chief financial officer will easily get to know that it can give high sales but due to
high investment and longer period to give return, it will not be worthwhile for the cited firm.
When NPV is calculated for the second Project concerning with Coal mining and oil
extraction, it indicates that an investment of $6 million needs to be made by the organisation in a
period of 1-2 years. Hence, it can be concluded that the risk involved is less. However, one
drawback is that the sales are low. But, considering the time scale that is required for the
recovered amount, it seems to be a better option. So, it will be the best one for the EyeWatering
Inc. NPV is regarded as the best method to take appropriate decisions regarding the investment
(Basic investment appraisal techniques, 2012).
The methods of NPV and PBP can be used in combination by EyeWatering Inc. this will
assist the firm in determining the actual return. Also, it will be enabled to make selection in a
project I which recovery of the spent amount can be made in least possible time. Hence, if both
the methods are utilized by the firm, then it can gain information about the risk as well as return.
Hence, the decision making process will be facilitated to a considerable degree.
CONCLUSION
The report proposed herewith indicates that financial resources are crucial element for the
organisation whose optimum utilization is highly important. The business unit is able to conduct
operations in an efficient manner through effective financial management. Profitability and cash
flow are inter-related, if finance manager manages, the cash flow then he/she can increase the
profitability of the enterprise. Working capital management supports in improving the economic
condition of the entity. NPV and Payback period are good methods of capital budgeting. By
using these techniques and enterprise can identify the risk and expected return on investment.
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REFERENCES
Books and Journals
Andor, G., Mohanty, S. K. and Toth, T., 2015. Capital budgeting practices: a survey of Central
and Eastern European firms. Emerging Markets Review. 23. pp.148-172.
Arráiz, I., Meléndez, M. and Stucchi, R., 2014. Partial credit guarantees and firm performance:
evidence from Colombia. Small Business Economics. 43(3). pp.711-724.
Bøhren, Ø. and Josefsen, M. G., 2013. Stakeholder rights and economic performance: The
profitability of nonprofits. Journal of Banking & Finance. 37(11). pp.4073-4086.
Bronzo, M. and et.al, 2013. Improving performance aligning business analytics with process
orientation. International Journal of Information Management. 33(2). pp.300-307.
Denis, D. J., Denis, D. K. and Walker, M. D., 2015. CEO assessment and the structure of newly
formed boards. Review of Financial Studies. 28(12). pp.3338-3366.
Desogus, G. and et.al, 2013. Economic efficiency of social housing thermal upgrade in
Mediterranean climate. Energy and Buildings. 57. pp.354-360.
Dichev, I. D. and Tang, V. W., 2014. The link between earnings volatility and earnings
predictability.
Ding, S., Guariglia, A. and Knight, J., 2013. Investment and financing constraints in China: does
working capital management make a difference?.Journal of Banking & Finance. 37(5).
pp.1490-1507.
Hartzell, J. C., Sun, L. and Titman, S., 2014. Institutional investors as monitors of corporate
diversification decisions: Evidence from real estate investment trusts. Journal of Corporate
Finance. 25. pp.61-72.
Mostafa, W. and Dixon, R., 2013. The impact of earnings extremity on information content of
cash flow. Review of Accounting and Finance. 12(1). pp.81-104.
Mukherjee, T. K. and et.al, 2013. Capital budgeting techniques in practice: US survey
evidence. Capital Budgeting Valuation: Financial Analysis for Today's Investment Projects.
pp.151-171.
Oladipupo, A. O. and Okafor, C. A., 2013. Relative contribution of working capital management
to corporate profitability and dividend payout ratio: Evidence from Nigeria. International
Journal of Business and Finance Research. 3(2). pp.11-20.
Online
Palacín-Sánchez, M. J., Ramírez-Herrera, L. M. and Di Pietro, F., 2013. Capital structure of
SMEs in Spanish regions. Small Business Economics. 41(2). pp.503-519.
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Robinson, D. T. and Sensoy, B. A., 2013. Do private equity fund managers earn their fees?
Compensation, ownership, and cash flow performance.Review of Financial Studies. 26(11).
pp.2760-2797.
Scott, J. F., Scott, J. M. and Cacho, O. J., 2013. Whole-farm returns show true profitability of
three different livestock management systems. Animal Production Science. 53(8). pp.780-
787.
Suhonen, N. and Okkonen, L., 2013. The Energy Services Company (ESCo) as business model
for heat entrepreneurship-A case study of North Karelia, Finland. Energy policy. 61. pp.783-
787.
Tang, Y. C. and Chang, C. T., 2012. Multicriteria decision-making based on goal programming
and fuzzy analytic hierarchy process: An application to capital budgeting
problem. Knowledge-Based Systems. 26. pp.288-293.
Van den Bogaerd, M. and Aerts, W., 2015. Does media reputation affect properties of accounts
payable?. European Management Journal. 33(1). pp.19-29.
Basic investment appraisal techniques, 2012. [Online]. Available through:
<http://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Basic%20investment
%20appraisal%20techniques.aspx>. [Accessed on 9th December 2016].
Investment appraisal techniques,2016. [Online]. Available through:
<https://www.nibusinessinfo.co.uk/content/investment-appraisal-techniques>. [Accessed on
9th December 2016].
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