Financial Analysis: Advantages and Disadvantages of Investment Appraisal Methods

Financial Analysis
Management & Enterprise

Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
Task 1.....................................................................................................................................3
..........................................................................................................................................................7
Task 2.....................................................................................................................................9
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................14

INTRODUCTION
Financial analysis is method by which corporations or large or small organizations take a
glance at their performance. It involves sustainability, consistency and efficiency. Financial
analysis may also be termed as analysis of financial statements (Choi and Luo, 2016). A
financial analysis relates to evaluation of how feasible, stable, liquid and financially viable an
enterprise or a proposal is. The concept can apply to an evaluation of how funds were being
spent effectively. Financial resources mean investments as well as debts in this sense. Financial
analysis management can also be a measure of the worth of assets or resources of the
organization. The study covers multiple aspects related to financial analysis and management to
understand main concept thoroughly. In study report first task critically evaluates the different
benefits and drawbacks or limitations of financial analysis techniques as method of investment
appraisal like NPV, IRR, pay-back etc.
MAIN BODY
Task 1
Critical analysis of advantages and disadvantages of using different kinds of investment appraisal
methods.
Net-present Value or NPV: The Net Present Value (NPV) technique is capital budgeting
assessment technique which clearly corresponds to capital investment to wealth maximization
objective (Pererva and Kobielieva, 2016). The NPV is amount which will immediately indicate
whether owners' capital will increase or decrease given an option to invest. As in given task NPV
of Large property investment is higher i.e. 7.5 million as compared to other two investments.
Thus Larger Development is most profitable investment with highest NPV. In this regard
following are several major advantages of this method as investment-appraisal technique, as
follows:
 The apparent benefit of net present-value approach is that this takes into consideration the
simple premise that future money is worth lesser than money today. Herein, cash flows
are being discounted by another period's cost of capital for each period.

 The NPV approach also informs us whether specific investment would generate value
for business or the investors, as well as how much.
 The NPV approach takes into account capital costs and the ambiguity involved in
creating future predictions. In fact, cash flows forecasts of different years into the future
are necessarily less assured than cash flows expected coming year. Cash flows which are
more expected in future would have less effect on NPV than more stable cash flows
which exist in previous periods.
Beside these discussed benefits, NPV approach has several drawbacks and limitations. Here
following are several considerable drawbacks or limitations of this method as discussed below:
 The biggest drawback to net present value approach is that this requires several
guesswork or estimates regarding rate of company's capital cost (Sweeting, 2017).
Having an overly lower cost of capital would contribute in the sub-optimal investments.
To assume that capital costs are too higher will led in too many effective investments
being forgotten.
 Moreover, the NPV approach is not effective when comparing two projects of similar
scale. Since the NPV approach resulted in dollar response, the magnitude of net present
value response is largely affected by the amount of input.
 A downside of NPV approach is that more complicated calculations are needed by the
client. The firm needs to measure every cash operation that occurs within project. The
business uses statistical tables, which have multipliers for varying periods of time
including interest rates. With each cash in or out flow the company has to find the right
multiplier and subtract the cash sum by multiplier. When the organization completes each
of those measurements, the balance is used to calculate project's/investment's NPV.
Payback Period: Payback period relates to a term in capital management which corresponds
to certain length of time which may be needed for project to produce revenues that will
compensate the corporation 's initial earnings during the execution of such a project (Zeghal and
El Aoun, 2016). The option among 2 or more proposals or investments to go for the is
generally one with have shortest payback time. It is calculated by merely by dividing the
sum used to begin project and the money produced by such project per annum. A project that has