Analysis of Investment Appraisal Techniques and Accounting Concepts

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Financial Decision Making
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Table of Contents
Question 2.......................................................................................................................................3
Question 4.......................................................................................................................................9
Question 5.....................................................................................................................................11
References.....................................................................................................................................13
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Question 2
Provide the advantages and disadvantages of investment appraisal techniques.
Payback period
Payback period as an investment appraisal technique provides details about the ability of the
enterprise to recover its initial investment. This investment technique is a method of capital
budgeting in financial management Payback is expressed in terms of years. In other words,
payback period is the actual time that an enterprise takes to recover its actual cost of the project
by using cash flows pertaining to that particular period while calculating payback period time
value of money is ignored (Alshatti, 2015).
Following is the formulae by which the payback period is calculated by enterprises:
A cut off period is established by the management of the enterprise to calculate the payback
period. Payback period is reached when the cumulative net cash flows of the enterprise reach its
break-even point. Most of the enterprise uses this appraisal technique to determine the feasibility
criteria of a particular project. A shorter payback period is most probably considered when a
comparison of the two projects is made regarding investment scenarios. Payback period is
focused to determine the liquidity position of the enterprise and all other investment appraisal
techniques are focused to determine the profitability position of the enterprise (Emmanuel,
2016).
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Following are the advantages of the payback period as an investment appraisal technique:
 Calculation of the payback period is simple and easy which makes this investment appraisal
technique more understandable than other complex techniques.
 Cash flows while determining the payback period can be easily adjusted when there is huge
uncertainty regarding future cash flows. Calculation of the payback period is flexible.
 Payback period is a measure of liquidity analysis of the enterprise as it determines the ability of
an enterprise regarding its repayment capabilities.
 Unlike any other investment appraisal techniques, payback period is the most cost-effective
technique.
 Uses cash flow not accounting profit, therefore, will not result in accounts manipulation.
Following are the disadvantages of payback period as an investment appraisal technique:
 Cash flow generated after the payback period are not considered.
 The concept of the required rate of return in this investment appraisal technique.
 The concept of the time value of money is entirely ignored in this investment appraisal
technique.
 Overall salvage value and economic value of project are not considered while calculating the
payback period.
 Major emphasis on recovery of capital and not on the profitability of the enterprise.
 Many enterprises while calculating pay back reject the positive net present value investments.
Net present value
Enterprise uses net present value as a capital budgeting technique to determine the actual
difference between the net cash flows and cash outflows pertaining to a particular time period.
To analyse the profitability, investment feasibility and for investment planning net present value
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technique is used. In other words, the net present value is the actual difference between the
market value of the investment project and cost of the investment project. In financial
management terms, Net present value is known as (NPV).
For evaluating the investment proposals by using modern method net present value technique is
used. Unlike the payback period technique this method doesn’t ignore the time value of money
concept. In net present value technique return on investments is calculated after considering the
element of time. (Magill, et. al., 2013)
Following is the formulae by which net present value of a project is calculated:
feasibility criteria based on net present value is evaluated after considering the value of cash
outflows if the cash outflows are negative then the project should not be selected and if the
project cash outflow is positive then the project should only be selected and if a project is
selected due to positive then it will indirectly beneficial to shareholders of the enterprise.
Following are the advantages of net present value as an investment appraisal technique:
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 Net present value is an excellent measure used for determining the profitability position of an
enterprise.
 Considers the concept of time value of money
 Unlike payback period technique all cash flows are considered in net present value technique
 More reliable than other capital budgeting techniques
 Net present value is a direct measure of the contribution involved in project
 By using the net present value method wealth maximization policies in the enterprise are
initiated.
 Net present value provides appropriate forecasts as this is the only technique which considers the
risk of future cash flows.
Following are the disadvantages of net present value as an investment appraisal technique:
 Based on the estimated future cash flows, therefore, is accuracy is not definite.
 Net present value involves complex calculation and therefore is difficult to understand.
 Final results derived by the net present value method are entirely based on the discounting rate
used.
 Comparison with other projects can only be made if the initial cost of the project is the same.
 Percentage rate on return on investment is not provided in this technique.
 Determination of the appropriate discount rate may lead to inaccurate results as net present value
technique is a difficult capital budgeting technique.
Internal Rate of return
The internal rate of return as an investment appraisal technique is used to determine the
attractiveness of a particular investment project. The internal rate of return is treated as an
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alternative of net present value technique. The internal rate of return is a discount rate that is
used to set the net present value of a particular project equals to zero (Santandrea, et. al., 2017).
In other words, the internal rate of return is the actual relative percentage which depicts the
return which the project will result in the future estimated the life of the project .internal rate is
also known as marginal efficiency of capital and in financial management terms internal rate of
return is termed as IRR. By using the following formulae enterprise calculate the internal rate of
return of projects:
While calculating the internal rate of return of projects enterprises use most probably to identify
the internal rate of return on balance of loans to make the unpaid balance of loans equals to zero
till the final payment of the loan. A project is selected if its calculated IRR is greater than the
cost of capital involved in the project.Higher IRR of a project depicts the huge profits involved
in the project as this capital budgeting technique is a profitability measure. Feasibility criteria to
accept or reject a project on the basis of IRR are ranks of different projects. A project is selected
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among many projects if its IRR is higher than others and that project will be the most desirable
for making huge profits in the future.
Following are the advantages of an internal rate of return (IRR) as an investment appraisal
technique:
 IRR depicts the actual return of the capital invested.
 The breakeven point is also derived in IRR technique.
 Considers the time value of money
 IRR is a common indicator of efficiency, quality and appropriate return on investment in an
enterprise.
 The most suitable and reliable technique as compared to other investment appraisal techniques.
Following are the disadvantages of internal rate of return (IRR) as an investment appraisal
technique:
 The internal rate of return technique is not suitable for mutually exclusive projects
 Overstated return is calculated if interim cash inflows of the enterprise are reinvested at a lower
rate than the calculated IRR.
 Not suitable for comparison among projects of different duration.
 IRR involves complex calculation and when compared to NPV of mutually exclusive projects
IRR projects conflicting results.
 Is not suitable for an enterprise that has multiple cash outflows because it will result in multiple
IRR.
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Question 4
Accounting concepts:
It can be explained as the set of basic assumptions and regulations that are required to be
followed by each business organization during the preparation of financial statements. These
concepts work to ensure the uniformity in financial accounts and enable the comparative analysis
of financial statements of two different organizations (Woodruff, 2018). Accruals, matching,
revenue recognition and more are some examples of accounting concepts and, some of them are
explained below;
Accruals:
It is one of the most crucial and basic accounting assumptions that is required to be followed by
the business organization during the creation of financial statements. As the concept of Accruals,
Revenues are required to be recorded as incomes when they occur by ignoring cash receipts.
Similarly, expenses are required to be included in the financial statement when they incurred by
ignoring the cash payment of such expenses (Gartenstein, 2018).
This system is highly useful and appropriate to clearly outline the real results of profitability
form periodic efforts. For example, a business which is selling goods on credit can clearly
identify the results of total sale that has been made during the considered period. Thus, this
concept is highly useful to correctly evaluate the results of business by ignoring the impact of
cash receipts and payments.
Going concern:
This concept refers to the ability of business to continue the operations for an unlimited period. It
can be explained as the basic accounting assumption which assumes that an entity will continue
the business for an infinite period so financial accounts are required by following the principle of
continuity (Woodruff, 2018). In other words, annual statements of a business are needed to be
prepared by assuming that business will sustain its operations unless there is a significant
situation of threat to the continuity of operations.
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If there is no sign of threat to the sustainability of the business, it will be assumed that conditions
of going concern are well. If financial managers believe that the organization will not able to
continue the operations, the financial statement should be made by considering the realizable
values of assets and real payable values of obligations (Unegbu, 2014). Following are some
indicators of a threat to going concern:
 Continuity of negative operational result and capital loss.
 Continuous Failure in timely repayment of loans and obligations.
 Adverse governmental actions against the company.
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Question 5
 Financial accounting:
It can be explained as the separate segment of accounting which is related to recording,
summarizing and classification of financial information so that financial statements can be
prepared in a most appropriate manner (Shpak, 2018).
 Management Accounting:
It is a systematic process that is related to the generation of managerial reports so that relevant
information regarding the financial and non-financial aspects of the business can be delivered
and managers can take most quality-based decisions (Karmakar, 2019).
Above explanations are proving that MA and FA are completely different from each other and
the same is provided below:
Base Financial accounting Management Accounting
Meaning
It is the process that is followed to
create financial reports.
It is a managerial process which is
related to the creation of internal
managerial reports.
Type of
information
Financial accounting delivers
information about the financial aspects
of the business. For example, reports
generated under the financial
accounting system present the
information related to net incomes,
Management accounting delivers
competitive information regarding the
non-financial aspects of business along
with monetary factors and assists the
business managers in quality strategic
planning and decision-making.
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costs and assets (Shpak, 2018).
Format and
time
Reports that are created under the
framework of financial accounting are
needed to be done as per the
prescribed format of IFRS regulations.
These financial statements are
prepared after the ending of each
financial year.
Reports that are created under the
management accounting framework are
not required to be prepared in a set
format. Business organizations can
several types of managerial reports as
per the requirement of situation and
nature of the organization.
Users of
reports
Statements that are prepared under
financial accounting frameworks are
utilized by the different stakeholders
for different purposes. These reports
are utilized by the internal and
external stakeholders to correctly
measure the security of their interest
(Karmakar, 2019).
Statements that are created under the
system of management accounting are
not relevant for the external
stakeholders and prepared to deliver
relevant information to internal
managers to enable the quality planning
and decision-making in managerial
efforts.
Publication
and
auditing
Publication of FA reports is necessary
under the law and principles of
auditing are applicable to these reports
as per the legal status of the
organization.
Publication of MA is not required under
the law because these are prepared to
assist the managers in decision-making.
Auditing principles are not applicable
to MA reports (Shpak, 2018).
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