Investment Appraisal Techniques and Risk Assessment using Accounting Ratios

Case study

TABLE OF CONTENTS
Assignment 2: A Case Study......................................................................................................3
Investment appraisal techniques............................................................................................3
Risk assessment using accounting ratios................................................................................6
Analysing and comparing the performance indicators.........................................................10
Role of pricing on the business performance.......................................................................10
REFERENCES.........................................................................................................................11

Assignment 2: A Case Study
Investment appraisal techniques
Accounting rate of return
Accounting rate of return is also known as average rate of return, is a financial ratio
used in the process of capital budgeting for evaluating the profitability of the investment
(Sampaio Filho, Vellasco and Tanscheit, 2018). ARR is very easy to use. It considers net
operating income which is used by creditors and investors for evaluating the performance of
the management.
Average
investment
£22500
Year
Cash
inflows
1 15000
2 15000
3 5000
4 5000
5 35000
Depreciation 35000
Total profit 40000
Average profit or cash
inflow 8000
Average initial
investment 22500
Average initial
investment [(initial
investment + scrap
Initial investment +Salvage value
2
£ 40000+ £ 5000
2

value) / 2]
ARR 36%
Thus, the accounting rate of return is the 36% by investing in the new project.
The payback period
It is the amount of time in which the amount invested in the project is expected to be
recovered (Sarwary, 2020). It determines the break-even point after which company starts
earning profits.
Year Total cash
flow
Cumulative
cash flow
0 -15000 -15000
1 1500 -13500
2 2750 -10750
3 4000 -6750
4 5700 -1050
5 7500 6450
Payback period 4.14 years
The payback period of the project that ABC Limited is willing to invest in acquiring
the new machine is 4.14 years. This indicates that the company should not go with the project
as the life of the project is 5 years and the payback period is 4.14 years which is much higher.
The net present value
It is one of the capital budgeting techniques which is calculated by determining the
difference between present value of both cash inflow and cash outflow (Benamraoui and
et.al, 2017). It is used for analysing the profitability of the projected investment. The positive
NPV means that investment can be made as projected earnings exceeds the anticipated cost.
Year Cash inflows
PV factor @
15%
Discounted
cash inflows
1 1500 0.870 1304