FINANCE 4 Investment Techniques Investment Techniques

FINANCE 4 Investment Techniques Investment Techniques Contents Purpose of this report 2 Investment Appraisal Techniques 2 ARR (Average Rate of Return) 2 NPV 2 IRR 3 Payback Period 3 Implementation of techniques on projects 4 Recommendations 4 Financing Methods Operating Activities for Sensations Corporation 4 Managing Working Capital 5 Conclusion 5 References 6 Appendix 1 7 Appendix 2 9 Appendix 3 11 Purpose of this report The main aim of this report is to discuss about the investment appraisal techniques. Investment Appraisal Techniques ARR (Average Rate of

Investment Techniques

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Contents
Purpose of this report...................................................................................................................................2
Investment Appraisal Techniques................................................................................................................2
ARR (Average Rate of Return)...............................................................................................................2
NPV.........................................................................................................................................................2
IRR..........................................................................................................................................................3
Payback Period........................................................................................................................................3
Implementation of techniques on projects...................................................................................................4
Recommendations.......................................................................................................................................4
Financing Operating Activities for Sensations Corporation........................................................................4
Managing Working Capital.........................................................................................................................5
Conclusion...................................................................................................................................................5
References...................................................................................................................................................6
Appendix 1..................................................................................................................................................7
Appendix 2..................................................................................................................................................9
Appendix 3................................................................................................................................................11

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Purpose of this report
The main aim of this report is to discuss about the investment appraisal techniques. There are
numerous techniques that can be used to determine the profitability from projects. In this report,
IRR, ARR, NPV and Payback Period are the methods will used to evaluate the Sensation
Corporation projects. After that, financing activities will be analyzed for the Sensation
Corporation.
Investment Appraisal Techniques
ARR (Average Rate of Return)
Advantages
 The main benefit of this technique is that it compares the new projects with the other
projects in terms of costing and revenue.
 The other advantage is to measures the amount of return on the basis of interest rate
(Money Matters, 2019).
Disadvantages
 The main disadvantage of this technique is to determine the fair rate of return which is
necessary for the firm to maintain the efficiency of a project.
 This method of investment did not recognize the external factors those directly affects the
profitability of the projects (CFI, 2019).
NPV
Advantages

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 NPV contains all transactions related to income and expenses.
 The main benefit of this technique is to determine the profit which the firm earns in the
coming future from the particular project.
Disadvantages
 It does not determine the required rate of return.
 This technique does not determine the projects of different sizes at the particular period
of time that decreases the chances of accurate results (Finance Management, 2019).
IRR
Advantages
 This technique evaluates the accurate rate of return of each project as per the cost of the
investment.
 The evaluation of rate of return recognized the time value of money (Alkaraan, 2017).
Disadvantages
 It is not able to consider the important factors such as future costs, project duration and
the size of project (Lanctot, 2019).
Payback Period
Advantages
 It helps to evaluate the time in which the firm can recover the interest expenditures.
 It is also very easy to understand this method or technique as compare to the others.

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Disadvantages
 According to this technique, cash flow has been ignored after evaluating the payback
period that directly affects the sum of return.
 It also ignores the time value of money (Accounting Skills, 2019).
Implementation of techniques on projects
Check in Appendix
Recommendations
As per Appendix 1, Sensation Corporation has to select the Project A as in this it has high
amount of NPV as compare to the others.
As per the Appendix 2, Sensation Corporation has to select the Project C as it recovers the
investment amount in fewer years as compare to the others.
According to Appendix 3, the firm has to select the Project C as it gets the high rate of return in
this.
Project C is recommended to the company as it is appropriate in terms of getting return or
generating profit.
Financing Operating Activities for Sensations Corporation
The company can finance the operating activities by issuing shares and bank loan. These
methods help the company to invest the funds in an appropriate way.

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Managing Working Capital
The company can manage the working capital by collecting the amount from debtors in less days
in order to maintain the cash in hand (Abor, 2017).
Conclusion
It is concluded that, Sensation Corporation has the opt. Project C as it covers the investment
amount in less period of time as compare to the others and also has high amount of rate of return.

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References
Abor, J.Y. (2017) Evaluating Capital Investment Decisions: Capital Budgeting. In
Entrepreneurial Finance for MSMEs (pp. 293-320). Palgrave Macmillan, Cham.
Accounting Skills. (2019) What Is Payback Period? (With Advantages & Disadvantages).
Available From: https://accountantskills.com/what-is-payback-period-what-are-the-advantages-
and-disadvantages-of-payback-period/[Accessed 19/2/2020].
CFI. (2019) ARR – Accounting Rate of Return. Available From:
https://corporatefinanceinstitute.com/resources/knowledge/accounting/arr-accounting-rate-of-
return/ [Accessed 19/2/2020].
Finance Management. (2019) Advantages and Disadvantages of NPV. Available From:
https://efinancemanagement.com/investment-decisions/advantages-and-disadvantages-of-npv
[Accessed 19/2/2020].
Lanctot, P. (2019) The Advantages and Disadvantages of the Internal Rate of Return Method.
Available From: https://smallbusiness.chron.com/advantages-disadvantages-internal-rate-return-
method-60935.html [Accessed 19/2/2020].
Money Matters. (2019) Accounting Rate of Return (ARR) Method | Advantages | Disadvantages.
Available From: https://accountlearning.com/accounting-rate-of-return-method-advantages-
disadvantages/ [Accessed 19/2/2020].

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Appendix 1
CASH IN/OUT FLOWS
Year Project A Project B Project C
0 -13,000 -13,000 -13,000
1 2,000 4,000 5,000
3 5,000 2,000 5,000
4 5,000 2,000 3,000
5 5,000 1,000 3,000
6 6,400 1,000 2,000
NPV and IRR
Project A
12%
Years 0 1 2 3 4 5 6
Initial Investment -13000
Annual cash flows 2000 4000 5000 5000 5000 6400
Net cash flows -13000 2000 4000 5000 5000 5000 6400
DCF 1.00 0.89 0.80 0.71 0.64 0.57 0.51
Present Value of Cash
Flows -13000
1785.7
1
3188.7
8
3558.9
0
3177.5
9
2837.1
3
3242.4
4
NPV
17790.5
5
IRR 9%

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Project B
12%
Years 0 1 2 3 4 5 6
Initial Investment -13000
Annual cash flows 4000 2000 2000 2000 1000 1000
Net cash flows -13000 4000 2000 2000 2000 1000 1000
DCF 1.00 0.89 0.80 0.71 0.64 0.57 0.51
Present Value of Cash
Flows -13000
3571.4
3
1594.3
9
1423.5
6
1271.0
4 567.43 506.63
NPV
8934.4
7
IRR -13%
Project C
12%
Years 0 1 2 3 4 5 6
Initial Investment -13000
Annual cash flows 5000 5000 5000 3000 3000 2000
Net cash flows -13000 5000 5000 5000 3000 3000 2000
DCF 1.00 0.89 0.80 0.71 0.64 0.57 0.51
Present Value of Cash -13000 4464.29 3985.97 3558.90 1906.55 1702.28 1013.26

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Flows
NPV 16631.25
IRR 10%
Appendix 2
PAYBACK PERIOD
Project A
Years
Net Cash
Flows CF
0 -13000 -13000
1 2000 -11000
2 4000 -7000
3 5000 -2000
4 5000 3000
5 5000 8000
6 6400 14400
14400
Payback
Period 2.60
Project B
Years Net Cash CF

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Flows
0 -13000 -13000
1 4000 -9000
2 2000 -7000
3 2000 -5000
4 2000 -3000
5 1000 -2000
6 1000 -1000
-1000
Payback
Period 7.00
Project C
Years
Net Cash
Flows CF
0 -13000 -13000
1 5000 -8000
2 5000 -3000
3 5000 2000
4 3000 5000
5 3000 8000
6 2000 10000
10000

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Payback
Period 1.40
Appendix 3
ARR
Project A
Average Revenue 4566.667
Average
Investment 13000
ARR Average Revenue
Average
Investment
ARR 4566.67
13000 35%
Project B
Average Revenue 2000.000
Average
Investment 13000

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ARR Average Revenue
Average
Investment
ARR 2000.00
13000 15%
Project C
Average Revenue 3833.333
Average
Investment 13000
ARR Average Revenue
Average
Investment
ARR 3833.33
13000 29%