Risk Management and Investment Appraisal Techniques

The assignment delves into the realm of project management and financial decision-making, examining the application of risk management and investment appraisal techniques. Specifically, it focuses on the Net Present Value (NPV) method as a tool for evaluating the profitability of projects, and sensitivity analysis as a means to mitigate risks by modifying equipment. The document emphasizes the significance of identifying and addressing potential risks in business projects to ensure adequate returns and minimize losses.

Topic

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
A) Calculation of NPV (Net Present Value) for Augmented Reality Glasses Project...........1
B) Accept or reject the project by analysing NPV and supporting qualitative and quantitative
reason......................................................................................................................................2
C) Producing risk management plan for the product market.................................................4
D) Application of quantitative risk assessment technique to model the risk.........................6
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................7

INTRODUCTION
Accountancy plays important role in company clarifying financial transactions in
effective way. Present report deals with investment appraisal method to select Augmented
Reality Glass Project on the basis of calculation of NPV in effectual manner. It is required so that
business may be able to select best alternative among various project and thus, project may be
carried out with better decision-making and adequate returns can be generated. Moreover, risk
management plan is made which is required in order to reduce consequences of risks quite
effectually.
A) Calculation of NPV (Net Present Value) for Augmented Reality Glasses Project
Particulars Year 0 Year 1 Year 2 Year 3
Revenue 15000000 15000000 15000000
Variable costs 6000000 6000000 6000000
Depreciation 1000000 1000000 1000000
EBIT 8000000 8000000 8000000
Less: Tax 2400000 2400000 2400000
Net income 5600000 5600000 5600000
Add: Depreciation 1000000 1000000 1000000
Capital expense 16000000
Salvage value 500000
Free cash flows 6600000 6600000 7100000
Present value
(Discounting
factor) @ 12 % 0.8928571429 0.7971938776 0.7117802478
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Discounted cash
flow 5892857.14 5261479.59 5053639.75
Total Discounted
cash flows 16207976
Total capital
expenditure 16000000
NPV (Total
Discounted cash
flows - Total
capital
expenditure) 207976
Workings-
Particulars Cash flows
Discounting factor
@ 12 %
Discounted cash
flow
1 6600000 0.8928571429 5892857.14
2 6600000 0.7971938776 5261479.59
3 7100000 0.7117802478 5053639.76
16207976
Initial capital
outlay 16000000
NPV 207976
Cost of capital is taken as 0.12 (12 / 100) for cash flows
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B) Accept or reject the project by analysing NPV and supporting qualitative and quantitative
reason
The capital investment appraisal methods are quite useful in assessing whether project
should be accepted or not. The techniques are NPV, IRR, payback period and ARR which are
helpful in evaluating attractiveness of new project in the best possible manner. These are quite
effective techniques helping business to make enhanced decision in order to select good return
yielding project in effectual manner. This is important so that business may not make investment
in low return yielding project which generates low cash inflows in certain time period. Hence, it
can be said that organisation is able to take decisions in effective manner. This is essentially
required because firm should invest in adequate generating returns in the best possible way.
Furthermore, company can easily take into account project and thus, make decision whether to
invest in the same or not.
In relation to this, NPV is taken as an investment appraisal method so to make analysis
whether to accept project or not quite effectually. NPV is a technique which is attained by taking
difference between cash outflows and inflows of a particular project in effective manner (Dung,
2016). In simple words, difference is effectively taken to analyse cash flows generated by
investing in project. It clarifies whether firm should invest in new undertaking or not so that
desired returns may be achieved quite effectually. NPV has several advantages to company in
taking correct decisions and earn higher returns. Among this, one of the main merit of NPV is
that it takes into consideration concept of time value of money while assessing attractiveness of
project. This implies that business is able to analyse in how much time, project will yield returns.
Another advantage of NPV is that it takes into account cost of capital for effectively
calculating cash flows which is required to effectively ascertain value of NPV and take decisions
thereon. On the other hand, it is advantageous as risk associated and inherent with the project is
also considered by the technique and thus, it can be said that risk associated within investing in
project and as such, it can be interpreted that firm will be able to take into account value derived
from NPV so that profits may be attained in effective manner. Furthermore, if NPV calculated is
negative means that it should not be accepted by the company in any way. NPV is said to be in
form of negative when total discounted cash flows are less in quantum in relation to the initial
investment or capital outlay (Crawford, 2016). Hence, when NPV comes positive, then only
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decision should be made to invest in project. The main reason behind is that positive returns will
be generated by company in the best possible manner. Furthermore, business will be able to
garner more returns and investment would be fruitful to it.
Merit of using NPV is that cash flows of before life of project and after cash flow
attained during the span of project are taken into consideration and calculation is made (What
Are the Advantages and Disadvantages of the Net Present Value Method?. 2018). This help
company to effectively ascertain whether it should invest in project or not. It is achieved because
clarity is attained by taking into account all the cash flows obtained before or after project in the
best possible manner. On the other side, profitability is ascertained regarding the investment in
new project and as such, if firm makes decision on profitability basis, then adequate returns will
be generated in the near future. Thus, it can be analysed that project is evaluated on the basis of
return yielding basis and firm can easily attain higher profits by relying on value obtained
through calculation of NPV. Moreover, firm' value is effectively maximised with the help of
taking NPV in consideration as all the project cash flows over life span is considered with much
ease. Hence, organisation can easily attain benefits out of the NPV.
It can be interpreted from the above calculation of NPV that Augmented Reality Glasses
Project may be accepted by organisation (Schneider, 2018). It is evident from the fact that
project initial outlay is 16 million and estimated life of project is 3 years. The revenues are
constant as it is 15,000,000 for next three years. On the other hand, variable costs are constant as
well in throughout life span of periods. Moreover, depreciation is provided on the fixed assets
amounting to 1,000,000. After that, EBIT is arrived and taxation is accounted for. Thus, net
income is attained and depreciation is added back to it for computing cash flows. Hence, inflows
are arrived at and there is a salvage value of 500,000 at the end of third year which is added to
achieve cash inflows for the year. Thus, it can be said that applying formula, NPV calculated is
207976 is attained which is good for the organisation as present value is positive.
The quantitative reason for supporting the answer is that firm will be able to garner
higher returns as NPV is positive and further, financial performance would be enhanced in a
better way. On the other hand, if qualitative reason for selecting Augmented Reality Glass
Project is that it will be beneficial for the society in attaining several benefits as to quickly
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capture images and feed information from internet. Hence, by carrying out analysis, it can be
recommended that firm can easily attain profits by investing in project in effective way.
C) Producing risk management plan for the product market
Risk management plan is made in order to identify risks and as such, take measures to
effectively reduce the same by implementing risk management plan. It is helpful for eradicating
risks up to a high extent (Olson and Wu, 2017). The plan for product market for Augmented
Reality Glass is listed below-
Consequences or effect
 Recover cost of equipment- The consequence of the project is that due to the risky nature
of project, benefits will not be attained in effective manner. There is probability of 50 %
that project will be successful and machines can be sold in 10 years amounting to
500,000. It will not be possible to recover cost of machinery in time span. The risk will
prevail as if machinery is not sold effectively, then equipment's cost cannot be recovered
by the company.
 Disposal issues- The issues related to the disposal is required to be undertaken in the best
possible manner. It is required so that it may be able to carry out the disposal of the old
machinery in effective way. The disposal can be made in by taking into consideration the
environmental factor so that no harm may be there. Thus, firm will be able to dispose off
equipment in effective manner (Kerzner and Kerzner, 2017).
 Machine depreciation- This is a charge over an asset which means that company will be
able to charge depreciation on the equipment over the useful life of 10 years. The
depreciation on the machinery is required to be made in order to correctly ascertain
profits in effective way. On the other hand, firm will attain difficulties as it will not
provide full use of equipment and depreciation would be charged on whole machinery.
This would prevail risk and as such, organisation will face losses as risk is high (Glaum,
Keller and Street, 2018).
 Operating and maintenance costs- The operating cost of the machinery is required to be
undertaken. The risk will prevail as firm will incur maintenance expenditures on the
machinery and thus, it will inculcate more risk to the company leading to decreased
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income. It is needed to be effectively handle expenses and reduction should be made as
probability of 50 % pass is not good for business in attaining objectives of Augmented
Reality Glass Project.
Rank of the Project
The rank is high because returns are lower and product market is risky
Proximity
The proximity is between 5-10 years
Management
After identification of risks, it is required to be implement ways in which risks can be
mitigated in effective manner. It is recommended that machine should be disposed off in the
event when cost of project cannot be recover within time span of two years. This would be
helpful in reducing risks quite effectually. Moreover, it should be sold to manufacturer of smart
glass. On the other hand, it can be modified for manufacturing and can be used in company.
Thus, risks can be alleviated with much ease.
D) Application of quantitative risk assessment technique to model the risk
The quantitative risk assessment techniques are used in order to decrease risks in the best
possible manner. There are various techniques of quantitative risk assessment that can be used in
project management so that risk can be modelled quite effectually. In relation to this, sensitivity
analysis is useful technique in context to the risk assessment. The means of modelling risks
should be aware by company in effective way. This is called sensitivity analysis or testing
(Sensitivity Analysis. 2018). It is implemented by organisation to effectively analyse various risks
associated with project from each and every angle so that potential impact can be analysed up to
a high extent. On the other hand, business is able to set priorities in order to achieve end
outcome.
By effectively knowing level of resultant impact of elements in effective way and
assisting in setting priorities quite effectually. The sensitivity analysis can be achieved through
easily conveying use of tornado diagram. Differences may be easily analysed and seen as
quantitative value is obtained. The impact of risks is qualified in numeric value only. It is used to
evaluate risks so that it can be minimised up to certain extent (Libby, 2017). The Augmented
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Reality Glass is risky project as in the market, sales are low. The sensitivity analysis can be used
to mitigate risks and if possible, equipment should be modify to reduce risks.
CONCLUSION
Hereby it can be concluded that investment appraisal technique is used to evaluate
attractiveness of project in effective manner. NPV is one such method helpful in assessing
profitability with regards to cash flow of project in effective manner. Furthermore, it is required
that firm will be able to enjoy adequate returns. Moreover, risk management plan is effective
plan because it identifies risks and then accordingly make recommendations to improve upon the
project so that risks may be alleviated up to a high extent. Furthermore, it is required that risks
associated with the project may be identified so that firm may be able to eradicate the same.
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REFERENCES
Books and Journals
Crawford, C. W., 2016. ACTG 201.05: Principles of Financial Accounting.
Dung, N. V., 2016. Value-relevance of financial statement information: A flexible application of
modern theories to the Vietnamese stock market. Quarterly Journal of Economics. 84.
pp.488-500.
Glaum, M., Keller, T. and Street, D. L., 2018. Discretionary accounting choices: the case of IAS
19 pension accounting.Accounting and Business Research. 48(2). pp.139-170.
Kerzner, H. and Kerzner, H. R., 2017. Project management: a systems approach to planning,
scheduling, and controlling. John Wiley & Sons.
Libby, R., 2017. Accounting and human information processing. In The Routledge Companion to
Behavioural Accounting Research (pp. 42-54). Routledge.
Olson, D. L. and Wu, D. D., 2017. Data Mining Models and Enterprise Risk Management.
In Enterprise Risk Management Models (pp. 119-132). Springer, Berlin, Heidelberg.
Schneider, A., 2018. Studies on the Impact of Accounting Information and Assurance on
Commercial Lending Judgments. Journal of Accounting Literature.
Online
What Are the Advantages and Disadvantages of the Net Present Value Method?. 2018 [Online]
Available Through: <https://www.fool.com/knowledge-center/advantages-and-disadvantages-of-
net-present-value.aspx>
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