INVESTMENT APPRAISAL (CAPITAL BUDGETING) TECHNIQUES

18th Dec 10:00 AM GMT

INVESTMENT APPRAISAL
(CAPITAL BUDGETING)
TECHNIQUES

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
Question: 1..................................................................................................................................3
Question 2...................................................................................................................................9
Question 3.................................................................................................................................10
Question 4.................................................................................................................................10
CONCLUSION..............................................................................................................................11
REFERENCES..............................................................................................................................12

INTRODUCTION
The project shall be highlighting two projects A and B on which various investment appraisal
techniques are apllied to find out which option to select and which one to reject.
MAIN BODY
Question: 1
PAYBACK PERIOD
PERIOD PROJECT A CUMULATIVE PROJECT B CUMULATIVE
Year 0 -5000 -5000
Year 1 700 700 500 500
Year 2 800 1500 0 500
Year 3 900 2400 3000 3500
Year 4 1000 3400 0 3500
Year 5 1100 4500 500 4000
Year 6 1200 5700 2000 6000
Year 7 1300 7000 0 6000
Year 8 1400 8400 1000 7000
Year 9 1500 9900 0 7000
Year 10 1600 11500 0 7000
Payback Period
No. of completed
years + (Required
amount /
Incremental
amount) 5.4166666667 5.5
DISCOUNTED PAYBACK PERIOD

PERIO
D PROJECT A COC @4%
DISCOUNT
ED @4%
CUMULA
TIVE
PRO
JEC
T B
COC
@4
%
DISCO
UNTED
@4%
CUM
ULA
TIVE
Year 0 -5000
-
5000
Year 1 700 0.962 673.077 673.077 500 0.962 480.769
480.7
69
Year 2 800 0.925 739.645 1412.722 0 0.925 0
480.7
69
Year 3 900 0.889 800.097 2212.819 3000 0.889
2666.98
9
3147.
758
Year 4 1000 0.855 854.804 3067.623 0 0.855 0
3147.
758
Year 5 1100 0.822 904.120 3971.743 500 0.822 410.964
3558.
722
Year 6 1200 0.790 948.377 4920.120 2000 0.790
1580.62
9
5139.
351
Year 7 1300 0.760 987.893 5908.013 0 0.760 0
5139.
351
Year 8 1400 0.731 1022.966 6930.979 1000 0.731 730.690
5870.
041
Year 9 1500 0.703 1053.880 7984.860 0 0.703 0
5870.
041
Year 10 1600 0.676 1080.903 9065.762 0 0.676 0
5870.
041
Discount
ed
Payback
Period
No. of
completed
years +
(Required
amount /
6.081 5.912

Incremental
amount)
NET PRESENT VALUE
Computation of NPV (A) Computation of NPV (B)
Year
Cash
inflows
PV
factor
@ 10%
Discoun
ted cash
inflows Year
Cash
inflows
PV
factor
@ 10%
Discoun
ted cash
inflows
1 700 0.962
673.076
9230769 1 500 0.962
480.769
2307692
2 800 0.925
739.644
9704142 2 0 0.925 0
3 900 0.889
800.096
7228038 3 3000 0.889
2666.98
9076012
8
4 1000 0.855
854.804
1910297 4 0 0.855 0
5 1100 0.822
904.119
8174353 5 500 0.822
410.963
5533797
6 1200 0.790
948.377
4308762 6 2000 0.790
1580.62
9051460
3
7 1300 0.760
987.893
1571627 7 0 0.760 0
8 1400 0.731
1022.96
6287002
8 8 1000 0.731
730.690
205002
9 1500 0.703 1053.88 9 0 0.703 0

0103368
3
10 1600 0.676
1080.90
2670121
3 10 0 0.676 0
Total
discount
ed cash
inflow 9066
Total
discount
ed cash
inflow 5870
Initial
investme
nt 5000
Initial
investme
nt 5000
NPV
(Total
discount
ed cash
inflows -
initial
investm
ent) 4066
NPV
(Total
discount
ed cash
inflows -
initial
investm
ent) 870
INTERNAL RATE OF RETURN
Computation of IRR (A) Computation of IRR (B)
Year Cash inflows Year Cash inflows
0 -5000 0 -5000
1 700 1 500
2 800 2 0
3 900 3 3000

4 1000 4 0
5 1100 5 500
6 1200 6 2000
7 1300 7 0
8 1400 8 1000
9 1500 9 0
10 1600 10 0
Internal rate of
return (IRR) 16%
Internal rate of return
(IRR) 8%
ACCOUNTING RATE OF RETURN
Computation of Average rate of return (A) Computation of Average rate of return (B)
Year Cash inflows Year
Cash
inflows
1 700 1 500
2 800 2 0
3 900 3 3000
4 1000 4 0
5 1100 5 500
6 1200 6 2000
7 1300 7 0
8 1400 8 1000
9 1500 9 0
10 1600 10 0
Average profit or
cash inflow 1150 Average profit or cash inflow 700
Average initial 5000 Average initial investment 5000

investment
average initial
investment [(initial
investment + scrap
value) / 2]
average initial investment
[(initial investment + scrap
value) / 2]
ARR 23% ARR 14%
SENSITIVITY ANALYSIS
PERIOD PROJECT A 10% up PROJECT B 10% up
Year 1 700 770 500 550
Year 2 800 880 0 0
Year 3 900 990 3000 3300
Year 4 1000 1100 0 0
Year 5 1100 1210 500 550
Year 6 1200 1320 2000 2200
Year 7 1300 1430 0 0
Year 8 1400 1540 1000 1100
Year 9 1500 1650 0 0
Year 10 1600 1760 0 0
PERIOD PROJECT A 10% down PROJECT B 10% down
Year 1 700 630 500 450
Year 2 800 720 0 0
Year 3 900 810 3000 2700
Year 4 1000 900 0 0
Year 5 1100 990 500 450

Year 6 1200 1080 2000 1800
Year 7 1300 1170 0 0
Year 8 1400 1260 1000 900
Year 9 1500 1350 0 0
Year 10 1600 1440 0 0
PERIOD
Cash flow
project A
10% up
PV factor @
4%
Discounted
cash inflow
(Project A)
Cash flow
project B
10% up
Discounted
cash inflow
(Project B)
1 770 0.962 740 550 529
2 880 0.925 814 0 0
3 990 0.889 880 3300 2934
4 1100 0.855 940 0 0
5 1210 0.822 995 550 452
6 1320 0.790 1043 2200 1739
7 1430 0.760 1087 0 0
8 1540 0.731 1125 1100 804
9 1650 0.703 1159 0 0
10 1760 0.676 1189 0 0
Total discounted cash
inflow 9972 6457
Less: Initial investment 5000 5000
NPV 4972 1457
PERIOD
Cash flow
project A
10% down
PV factor @
4%
Discounted
cash inflow
(Project A)
Cash flow
project B
10% down
Discounted
cash inflow
(Project B)

1 630 0.962 606 450 433
2 720 0.925 666 0 0
3 810 0.889 720 2700 2400
4 900 0.855 769 0 0
5 990 0.822 814 450 370
6 1080 0.790 854 1800 1423
7 1170 0.760 889 0 0
8 1260 0.731 921 900 658
9 1350 0.703 948 0 0
10 1440 0.676 973 0 0
Total discounted cash
inflow 8159 5283
Less: Initial investment 5000 5000
NPV 3159 283
Question 2
The advantages and disadvantages of various investment appraisal techniques:-
S.NO TECHNIQUES ADVANTAGES DISADVANTAGES
1) Payback Period  Simplest technique to use
and understand
 Considering the element of
liquidity
 Unrealistic approach as
profitability is not
considered
 Time value of money is
ignored
2) Discounted
Payback Period
 Preferred over payback as
time value of money is used
 Determination of actual risk
involved
 Does not facilitate the
decision making
regarding accepting or
rejecting the proposal
 Calculations are complex

as compared to payback
3) Accounting
Rate of Return
 Measures the profitability
of the project
 It considers the earnings
after tax and depreciation
 Major weakness of
ignoring time value to
judge the proposal
 Different from return on
investment and so
decision making becomes
tough
4) Net Present
Value
 It facilates decision making
as if NPV is positive the
project is to be accepted
and vive versa.
 It includes time value of
money
 Projects of different sizes
cannot be compared
 It only considers the cash
inflows and outflows but
ignores the hidden and
preliminary costs
5) Internal Rate of
Return
 Hurdle rate is not required
in the calculation of IRR
 Comparing IRR with the
estimated required rate
decision can be made
 Mutually exclusive or
contingent projects cant
use the technique to make
the decision
 The concept of
economies of scale is
completely ignored
6) Sensitivity
Analysis
 It is helpful in decision
making process
 It helps in analyzing the
weak points of the proposal
and strengthening the same
 Its based on various
assumptions
 Not relative in nature
Question 3
Stability of the project- In terms of the stability project A is more stable as compared to project B
(Borgonovo, 2017). This is because Project B is not able to generate constant returns, in some

years the returns or the cash inflows are very high but in others they are simply nil. This can be
major concern as it will impact the liquidity position of the company. The consistency of Project
A is comparatively very high as the returns are increasing with same amount (Dor and Elovici,
2016).
Question 4
 Payback Period- The payback period shows the time taken to recover the investment by
the company (Elmassri, Harris and Carter, 2016). It is the breakeven point of the
investment. The project A is recovering its investment in 5 years 4 months whereas
Project B is 5 years 5 months. Project A should be accepted as its recovering the
investment in shorter period (Fokkema, Buijs and Vis, 2017).
 Discounted Payback Period- It considers time value of money in calculating payback.
According to this technique Project B is viable as it is taking lesser time than Project A.
the investment shall be recovered a month earlier in Project B.
 Accounting Rate of Return- It shows the percentage rate of return that the company may
expect to generate on the investment made (Li and Trutnevyte, 2017). As per this
technique Project A must be accepted which is generating returns upto 23% as compared
to Project B bringing returns upto14%.
 Net Present Value- It shows the difference between present value of cash inflows and
cash outflows. The project with higher NPV which is A has to be selected as compared to
Project B.
 Internal Rate of Return- It represents the annual potential growth rate of an investment.
The higher is the rate the more desirable the project (Schlegel, Frank and Britzelmaier,
2016). In this case Project A shall be selected as it has double the rate as compared to
Project B.
CONCLUSION
The project shows that as in most of the techniques Project A has prevailed so it is suggested
that it should be accepted in comparison to Project B.

REFERENCES
Books and Journals
Borgonovo, E., 2017. Sensitivity analysis. Number. 251. pp.93-100.
Dor, D. and Elovici, Y., 2016. A model of the information security investment decision-making
process. Computers & security. 63. pp.1-13.
Elmassri, M.M., Harris, E.P. and Carter, D.B., 2016. Accounting for strategic investment
decision-making under extreme uncertainty. The British Accounting Review. 48(2).
pp.151-168.
Fokkema, J.E., Buijs, P. and Vis, I.F., 2017. An investment appraisal method to compare LNG-
fueled and conventional vessels. Transportation Research Part D: Transport and
Environment. 56. pp.229-240.
Li, F.G. and Trutnevyte, E., 2017. Investment appraisal of cost-optimal and near-optimal
pathways for the UK electricity sector transition to 2050. Applied energy. 189. pp.89-
109.
Schlegel, D., Frank, F. and Britzelmaier, B., 2016. Investment decisions and capital budgeting
practices in German manufacturing companies. International Journal of Business and
Globalisation. 16(1). pp.66-78.
Online
INVESTMENT APPRAISAL TECHNIQUES. 2020. [Online]. Available through:
<https://competency.aicpa.org/media_resources/208759-investment-appraisal-
techniques-i>
Investment Appraisal Techniques. 2020. [Online]. Available through:
<https://efinancemanagement.com/investment-decisions/investment-appraisal-
techniques>