Investment Appraisal Methods & Applications

This assignment delves into the realm of investment appraisal, examining different methods used to evaluate potential investments. Students will analyze various techniques such as net present value (NPV), internal rate of return (IRR), and others. The focus lies on understanding the theoretical underpinnings of these methods and their practical applications across diverse industries like property development, energy projects, and sustainable rural development. Case studies and examples are utilized to illustrate the application of these methods in real-world scenarios.

Accounting and Decision
Making

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
PART 1: BUSINESS PERFORMANCE ANALYSIS....................................................................1
Interpreting the statement of Profit or Loss............................................................................1
Analysing the statement of cash flows...................................................................................3
Stating the advantages and limitations of ratio analysis.........................................................6
PART 2: INVESTMENT APPRAISAL..........................................................................................7
Evaluating investment appraisal techniques Western Europe expansion plan.......................7
NON-FINANCIAL FACTORS.....................................................................................................10
Advising board of director in relation to non-financial factors in decision making............10
SOURCES OF INTERNAL FINANCE........................................................................................10
Evaluating three internal sources of finance........................................................................10
PART 3..........................................................................................................................................11
CONCLUSION..............................................................................................................................11
REFERENCES..............................................................................................................................13

TABLE OF FIGURES
Figure 1: Investment Appraisal Techniques....................................................................................7

INDEX OF TABLES
Table 1: Ratios calculation for Tusker Plc for the year 2014 and 2015..........................................1
Table 2: Calculation of more Ratios for Tusker plc........................................................................3
Table 3: Calculation of Payback period...........................................................................................7
Table 4: Calculation of Net present value.......................................................................................9

INTRODUCTION
Accounting is the most important field of finance that provides deeper insight into the
financial transactions of the company. Each and every organization prepares Income &
Expenditure, cash flow and balance sheet statements to assess their financial health and
performance. These statements help business units in assessing their financial position with the
help of ratio analysis (Di Lorenzo and et.al., 2012). Through this, corporation is able to make
effectual decisions which make contribution in the attainment of organizational goals. Besides
this, investment appraisal techniques also provide assistance to the finance manager in making
suitable investment decisions. The present report is based on Tusker Plc which is the building
and home improvement merchant firm. According to as mentioned in given study, the cited firm
supplies range of materials to trade professionals through retail stores. This report will shed light
on financial performance of Tusker plc with the help of ratio analysis. Further, it will also
provide information about the project which offers high benefit to the firm.
PART 1: BUSINESS PERFORMANCE ANALYSIS
Interpreting the statement of Profit or Loss
Income and Expenditure account (a/c) provides information about revenue generated by
the firm during the accounting year. Further, it also entails the expenditures which are incurred
while performing the business operations and functions (Hill and 2011). With the help of such
statement, Tusker plc is able to evaluate its profitability for the year of 2015 in against to 2014.
Thus, by making assessment of revenue, gross, net profit as-well-as return on capital employed,
company can evaluate its financial strategies or success to the great extent.
Table 1: Ratios calculation for Tusker Plc for the year 2014 and 2015
RATIOS FORMULA 2015 2014
Revenue growth Revenue 2015/
revenue 2014 * 100
316/298 * 100 = 6%
Gross profit margin Gross profit / net sales
*100
59/316 *100 = 18.7% 30/298 *100 = 10.1%
Net profit margin Net profit / net sales
*100
26/316 *100 = 8.2% 1/ 298 *100 = 0.3%
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ROCE Operating profit /
equity + Debt *100
26 / 203+180 * 100 =
6.8%
1/ 178+109 * 100 =
0.3%
 Growth in revenue: Tusker plc can easily identify the level of growth by making
comparison of the sales of present year with the previous one. It enables firm to evaluate
the extent to which they attain success in raising their sales as compared to before years.
By making analysis of sales aspect, it has been identified that sales revenue of Tusker plc
is inclined from 6% in the year of 2015 as compared to 2014. This aspect clearly reflects
that sales policies and strategies of the firm are sound. In addition to this, growing market
condition had also placed positive impact upon the sales pattern of business unit. Thus,
company continuously needs to make its finest efforts which help them in enhancing the
sales to the significant level.
 Gross profit (GP) ratio: GP is one of the most effectual measures which helps the
organisation in assessing the level of profit which is generated by them by selling product
or services (Hill and et.al., 2011). In the financial year 2014, GP margin of the firm is
10.1% whereas it increased in 2015 in which; it is 18.7%. It shows that Tusker Plc sells
its inventory more effectively and thereby attaining from it.
 Net Profit (NP) ratio: It presents the profit which is earned by the firm during the
accounting period after deducting all the expenditures which are made by them. Net
margin of the firm shows the amount which is available to the company for giving
dividend to shareholders. Moreover, their investment decision is highly dependent on the
profit which is earned by the business organization during the period. NP margin of the
firm shows significant increase in its profitability aspect. Moreover, in 2015, NP ratio of
Tusker Plc is 8.2% whereas it is .3% in the year of 2015. On the basis of this aspect, it
can be said that company had generated enough amount of profit by making several
indirect expenditure. Through this, organisation is able to attract several stakeholders
towards making investment in the firm's operation.
 Return on capital employed: It is the measures which entails how efficiently firm makes
use of its capital in relation to the generation of profit. One can easily assess the
organisation's efficiency by making comparison of net profitability. Thus, NP margin of
the firm is higher in the accounting period 2015 as compared to 2014.
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Therefore, by making assessment of profit or loss a/c, it has found that profitability aspect
of Tusker plc is sound as compared to previous year. Thus, company needs to enhance its
profitability by making further investment in the other profitable projects. As per the cited case
scenario, building and construction market is continuously growing. In this, Tusker plc can
maximize its profitability by entering or serving more number of customers in the UK market.
Analysing the statement of cash flows
Cash flow statement of the firm renders information about the activities which are highly
associated with the inflow and outflow of financial resources. Operating, financing and investing
activities are the main aspect of such statement which helps organisation in assessing that
whether they have sufficient amount of cash or not (Keršuliene, Zavadskas and Turskis, 2010).
Moreover, effective execution of the business plan is highly dependent upon the financial
position of the firm. According to the cited case scenario, profit before tax of Tusker plc is £12
million for the year ended 31st December, 2015. Thus, by making assessment of liquidity,
solvency and efficiency ratios, Company can easily assess the changes which take place in the
cash or monetary position.
Table 2: Calculation of more Ratios for Tusker plc
RATIOS FORMULA 2015 2014
Liquidity ratio
Current ratio Current assets / current
liabilities
107 /105 = 1.02 89 /4 0 = 2.23
Quick ratio CA – stock or
inventory / CL
107 – 64 /105 = .41 89 - 53 /4 0 = 0.90
Solvency ratio
Interest cover ratio Operating profit /
finance cost
26/ 14 = 1.86 1/ 9 = .11
Gearing ratio Debt / debt + equity 180 / 180 + 203 * 100
= 47%
109 / 109 + 178 * 100
= 38%
Efficiency ratios
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Inventory days Inventories / cost of
sales
64/ 257 * 365 = 91
days
29/ 298 * 365 = 36
days
Receivable days Trade receivables /
revenue
43 / 316 * 365 = 50
days
64/ 257 * 365 = 91
days
Payable days Trade payable / cost of
goods sold
58 / 257 * 365 = 82
days
40 / 268 * 365 = 54
days
Operating cycle  (+) Inventory
days
 (+) Receivable
days
 (-) Payable
days
 (-) operating
cycle
91+ 50 -82 = 58 72+ 36 -54 = 53
Liquidity ratios: This ratio furnishes information about the financial capability of the firm in
relation to the meeting of current or short term obligations. From current and quick ratio, Tusker
plc can easily evaluate its liquidity or financial position.
 Current Ratio (CR): This financial ratio of the firm entails that whether firm has
sufficient resources to meet its current obligations over the next 12 years or not (Nieto-
Borge and et.al., 2008). From the above table, it can be stated that in the year 2015,
Tusker plc has less Current Assets (CA) to meet its liabilities. In 2014, current ratio of the
business unit is 2.23: 1 whereas it is 1.02:1 in the 2015. One of the main causes behind
such decrease in reduction is the current assets of firm. Thus, company had released more
of its CA for the business purpose. Due to this, cash inflow is lower than the outflow. In
2015, CR of Tusker plc is very far from the ideal ratio which is 2:1. Hence, company is
not highly capable in relation to the payment of its current obligations from the assets of
firm. This aspect negatively affects the growth and success of business organization.
 Quick Ratio (QR): It shows the level of CA excepting inventory which can easily be
converted by the firm into cash (Kumbirai and Webb, 2013). In 2014, QR of Tusker plc
was .90:1 which decreased in 2015 as .40:1. On the basis of this aspect, it can be said that
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business unit made more use of cash, bank, debtors and other current assets except
inventory. It is also one of the main reasons due to which outflow of the firm is more
rather than inflow. In 2015, QR of the firm is very near to the ideal ratio which is .5:1. It
shows positive sign for the firm.
Solvency ratio: This ratio helps business organisations in assessing their financial capability in
relation to the meeting of long term obligations. Debt-equity, interest coverage ratio etc. are the
main elements which provide information about the financial capacity of the firm.
 Interest cover ratio: From the above mentioned calculation, it has been assessed that
Tusker plc is able to pay interest and other outstanding debt on time. Moreover, in the
accounting year 2015, interest coverage ratio of the firm is higher as compared to 2014 in
which it was .11:1.
 Gearing ratio: Debt-equity ratio of Tusker plc increased in the year 2015 as compared to
2014 (Guo and et.al., 2010). This ratio entails the extent to which fund is raised by the
firm through debt instrument rather than equity. Ideal debt-equity ratio is .5:1 which
states that business organisation requires to fulfil its financial need by issuing equity
rather than debt instruments. In the financial year 2014, debt-equity ratio of Tusker plc
is .61:1 which is near to the ideal ratio. On contrary to this, in 2015; debt-equity ratio of
the business organization is .88:1. It clearly reflects that company has fulfilled more of its
financial requirements from debt instruments as compared to equity. Therefore, company
needs to make periodical payment to the debt-holders. Moreover, in equity, company
requires to pay dividend only when they generate enough amount of profit. In this,
interest amount have high level of impact upon outflow or profitability aspect of the firm.
Efficiency ratios
 Inventory turnover ratio: This ratio of the firm is getting inclined in 2015 as compared to
2014. Moreover, in 2015 inventory turnover period is 91 days which shows that Tusker
plc is efficiently able to covert its inventory into finished goods. Thus, it helps
organisation to supply the products in the suitable time frame.
 Receivable days: This ratio of the firm shows that it is able to get payment earlier from its
debtor (Baum and Crosby, 2014). In 2015, receivable turnover ratio is 50 days whereas
Tusker plc had to wait for 91 days for the recovery of payment from debtors in 2014.
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This is a positive sign for the firm because by receiving earlier payment, company is able
to make investment in the further productive activities.
 Payable days: In 2014, Tusker plc took 54 days for making payment to creditors for the
material which is purchased on credit basis. On contrast to this, in the year 2015, payable
days of Tusker plc are increased to 82 days which is good for the company.
By making analysis of efficiency ratio, it can be said that Tusker plc has to make
payment to their creditors within 82 days whereas it received payment from debtors within 50
days. Thus, by taking into this fact consideration, it can be stated that Tusker plc had efficiently
managed its business operations.
Stating the advantages and limitations of ratio analysis
There are several drawbacks and benefits which are associated with the financial ratio
analysis and are as follows:
Advantages: By doing ratio analysis, Tusker plc can effectively evaluate its financial statements.
By this, company is able to assess its financial performance and health to the large extent. In
addition to this, it also provides opportunity to the business organization to make evaluation of
the strategies and policies which are employed by them (Di Lorenzo and et.al., 2012). Along
with this, with the assistance of ratios, company is able to formulate competent plan which helps
them in improving their financial position and performance. For instance; from the analysis of
cash flow statement, it has found by the company that they need to make balance in their
financial structure. In addition to this, they also required to make improvement in their current
ratio.
Limitations: In financial statement, prices of the asset are recorded at cost only. Thus, it does
not reflect the changes which actually took place in the price level. Beside this, lack of
standardized rules and regulations also has high level of influence upon the appropriateness of
the ratios. Further, financial statements are the subject of high level of manipulation (Calabrò and
Della Spina, 2013). Thus, company or other stakeholders are unable to derive valid conclusion
by making analysis of ratios. Along with it, different accounting policies which are employed by
the firm closely affect the reliability or validity of the outcomes of ratios (Ratio Analysis:
Meaning, Advantages and Limitations Accounting, 2015).
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PART 2: INVESTMENT APPRAISAL
Evaluating investment appraisal techniques Western Europe expansion plan
Capital budgeting is the most effectual financial tool or technique which helps finance
manager of the firm in making suitable investment decisions. Payback period, Net Present Value
(NPV) and ARR (Average Rate of Return) etc. helps business unit in assessing the financial
viability of the project.
Figure 1: Investment Appraisal Techniques
 Payback period: This measure of capital budgeting refers to the time period in which
organisation is able to recover the money that are initially invested by the firm (Eliasson
and Börjesson, 2014). Thus, company is required to make assessment of the time within
which they are able to get break-even point.
Table 3: Calculation of back Payback period
YEAR CASH INFLOW (£'000) CUMULATIVE CASH
INFLOW (£'000)
0 -120 -120
1 12 -108
2 24 -84
3 30 -54
4 36 -18
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InvestmentappraisaltechniquesPaybackperiodAverageRateofReturn(ARR)NetPresentValue(NPV)

5 45 27
Payback period = 4+ (18+45)*12
= 4.5 years
On the basis of above mentioned calculation, it has been assessed that Tusker plc will
take 4 years and 5 months to recover its initial investment of 120 million. Moreover, firm will
take period of 5 years for the assessment of payback period. Thus, by taking payback period into
consideration, it can be stated that company should avoid making investment in the project of
Western Europe. Moreover, payback period is higher so project does not prove to be fruitful for
the firm. This method clearly reflects the time period which is required by the firm for
recovering its initial investment. Business unit can easily identify the time period thereafter; it is
able to make profit. Whereas, this method completely ignores the time value of money concept
which limits the significance of this method (What are the limitations of capital budgeting?,
2016).
 Average Rate of Return (ARR): This entails the average profit which business
organization will earn from the proposed capital investment (Hahn, Figge and Liesen,
2012).
ARR = Average annual profit from investment / average investment *100
Average profit (£'000) = 12 + 24 + 30 +36 +45 = 147
= (147-120) / 5 years = £5.4 million
Average value of asset = 120/2= 60
Average rate of return = (5.64 / 60) * 100 = 9%
According to the cited case scenario, targeted ARR of Tusker plc is 8%. From the
calculation, it has been analysed that company will get 9% as an average return during the period
of five years. By considering this fact it can be said that there business unit will enjoy more
benefit in the near future by making investment in Western European market. From this method,
finance manager can easily evaluate its profitability aspects in future context. On the contrary to
this, ARR method of capital budgeting also does not consider the time value of money concept
which has high importance in the present business environment (Almarri and Blackwell, 2014).
Thus, it is one of the main limitations of the firm which impacts the effectiveness of such tool.
 Net Present Value (NPV): This measure of investment appraisal furnishes the return
which is earned by the firm after the period of years. This method plays a vital role in the
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selection of suitable project because; it undertakes discounting factor for the calculation
of inflow.
Table 4: Calculation of Net present value
YEAR CASH INFLOW
(£'000)
DISCOUNTING
FACTOR @ 5%
DISCOUNTED
CASH INFLOW
0 -120 1 -120
1 12 0.95 11
2 24 0.91 22
3 30 0.86 26
4 36 0.82 30
5 45 0.78 35
Total
discounted
cash flow
124
Net present
value (Total
discounted
cash inflow –
initial
investment)
(124 – 120 ) 4
The above table shows that Tusker will get £4 million return after the period of five
years. This method offers highly realistic results because; it considers time vale of money
concept. Through this, company can easily assess the return which they will get after the
predetermined time period. Nevertheless, in this tool finance manager is required to make an
estimation of the cost of capital for discounting the cash flow. If this estimation is wrong then,
finance manager is unable to present the suitable decision.
Thus, by keeping the benefits and drawbacks of the investment appraisal tool in mind,
company should make investment in the Western European market. Moreover, calculated ARR
is higher than the targeted amount. In addition to this, net present value of the Western European
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project is positive. Thus, business unit needs to make investment in such project which helps
them in maximizing their productivity and profitability.
NON-FINANCIAL FACTORS
Advising board of director in relation to non-financial factors in decision making
Board of Director (BOD) of the firm also needs to undertake non-financial factor which
have high level of influence upon the growth and profitability aspect of the firm. These factors
include availability of the skilled personnel, employee, customer retention rates, new product
development, innovation etc. which higher authority requires considering in the decision making
aspects (Koehler and Harvey, 2008). Moreover, productivity and profitability of the firm is
highly associated with the skills and abilities of the personnel. Thus, Tusker plc needs to recruit
skilled and efficient personnel who are able to make delivery of the products or services more
effectively. Through this, firm is able to maximize the employee productivity and profitability.
Along with this, BOD also requires to undertake motivational tools and technique which helps
them in retaining their workforce for longer duration. Further, Tusker plc also needs to make
focus on the offering of innovative product or service to the customers of Western European
market. Thus, with the help of unique products, business unit is able to build or sustain distinct
image in the mind of target customers. Hence, by following all the above mentioned non-
financial factors, BOD of Tusker plc is able to expand its business operations in Western
European market more successfully.
SOURCES OF INTERNAL FINANCE
Evaluating three internal sources of finance
In accordance with the given case situation, expansion project of Western European
market is partly funded by the long term sources of finance. In this, managing director of firm is
highly concerned about the sources which he can undertake for meeting the financial need. Thus,
along with external, there are several internal sources of finance which are available to David
who is the MD of Tusker plc and are enumerated as below:
 Retained profit: It is the part of profit which every organization retains with itself after
making payment of tax amount. Business organisation retains this amount with the
objective of meeting contingent situation which will arise in near future (Kaplan and
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Atkinson, 2015). Thus, by making the use of retained profit, Tusker plc can expand its
business in Western European market.
 Sale of assets: Tusker plc can also raise finance by selling the non-profitable assets which
have no further use in the productive activities. Through this, company can easily meet its
financial need by selling the non- profitable assets.
 Working capital: Company can also make use of the working capital which is maintained
by the firm. It presents the balance of current assets and liabilities. Positive balance
shows that company has enough amounts of financial resources to meet its obligations.
Thus, Tusker plc can expand its business by taking financial assistance from working
capital.
PART 3
CONCLUSION
From the above report, it can be concluded that profitability aspect of Tusker plc is sound
in the year 2015 as compared to 2014. Further, it can be inferred that liquidity of the firm
decreased. Besides this, company has fulfilled its financial needs from debt instruments rather
than equity. Due to this, cash flow of the firm is decreased to the large extent. From this study, it
can also be articulated that NPV of the project is positive whereas ARR exceeded the target
return. On the basis of this aspect, Tusker plc needs to make investment in Western European
market which proves to be more beneficial for it. In addition to this, non-financial factors also
play vital role in effective decision making. Through this, company is able to achieve success in
the strategic business arena.
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