University of Wales: IFM Assignment - Investment Appraisal Techniques

This report, prepared for an International Financial Management course, evaluates the financial viability of an investment using various investment appraisal techniques, including Payback Period, Accounting Rate of Return (ARR), and Net Present Value (NPV), considering both Cost of Capital and Hurdle Rate scenarios. The report then critically appraises the use of these different methods, discussing their strengths and weaknesses in assessing the profitability and risk associated with the investment. Furthermore, it delves into the non-financial factors, such as legal compliance, project capacity, industry standards, maintenance requirements, human and social factors, and the importance of training, that must be considered alongside financial metrics to make informed investment decisions. The analysis provides a comprehensive overview of the investment appraisal process, combining quantitative financial analysis with qualitative considerations for a holistic evaluation.

INTERNATIONAL FINANCIAL
MANAGEMENT

TABLE OF CONTENTS
TABLE OF CONTENTS................................................................................................................2
QUESTION.....................................................................................................................................1
a) Evaluating financial viability of the investment using investment appraisal techniques........1
b) Critically appraising the use of different methods of investment appraisal............................4
c) Non Financial Factors to be considered in the investments appraisal.....................................5
REFERENCES................................................................................................................................8

QUESTION
a) Evaluating financial viability of the investment using investment appraisal techniques.
Initial
Investment 1000000
Life 7 years
Annual cash
flow 190000
Residual Value 150000
Cost of Capital 8%
Hurdle Rate 12%
Payback Period
Computation of Payback period
Year
Cash
inflows
Cumulative cash
inflows
1 190000 190000
2 190000 380000
3 190000 570000
4 190000 760000
5 190000 950000
6 190000 1140000
7 190000 1330000
Initial
investment 1000000
Payback
period 5
0.3
Payback
period
5 year and 4
months
Accounting Rate of Return
Computation of Average rate of return
Year Cash inflows
1 190000
1

2 190000
3 190000
4 190000
5 190000
6 190000
7 190000
Average profit or cash inflow 190000
Average initial investment 1000000
average initial investment
[(initial investment + scrap
value) / 2]
ARR 19%
Net Present Value (Using Cost of Capital )
Computation of NPV
Year
Cash
inflows
PV
facto
r @
8%
Discounte
d cash
inflows
1 190000 0.926 175926
2 190000 0.857 162894
3 190000 0.794 150828
4 190000 0.735 139656
5 190000 0.681 129311
6 190000 0.630 119732
7 190000 0.583 110863
7 150000 0.583 87523.6
Total discounted cash
inflow 1076734
Initial investment 1000000
NPV (Total discounted
cash inflows - initial
investment) 76734
Net Present Value ( Using Hurdle Rate)
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Computation of NPV
Year
Cash
inflows
PV factor
@ 12%
Discounted
cash inflows
1 190000 0.893 169643
2 190000 0.797 151467
3 190000 0.712 135238
4 190000 0.636 120748
5 190000 0.567 107811
6 190000 0.507 96259.9
7 190000 0.452 85946.4
7 150000 0.452 67852.4
Total discounted cash
inflow 934966
Initial investment 1000000
NPV (Total discounted
cash inflows - initial
investment) -65034
b) Critically appraising the use of different methods of investment appraisal
Every company is required to analyse the viability of the proposed investment for the
business. There are different investment appraisal techniques that are used by the organisation
such as net present value, payback period, accounting rate of return and internal rate of return.
The methods enable the management to identify the profitability of the proposed project or
investments chosen for the business (Milenković and et.al., 2016). By effectively assessing the
returns, profitability and recovery of cost of investment management choose the most beneficial
option from among the different options available.
Payback period
Payback period refers time that investment will take to recoup the investments. Payback
period is used typically for evaluating the investment or projects before undergoing by
evaluating risks associated with them investment could have long or shorter pay back period.
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Short payback period refers to the investment that will be recovered fairly and shortly. Cost of
the investments will be recovered quickly by cash flows generated from the project. For
investment short payback period is generally considered as the risk associated with investment
will be only for short time period. The method is also considered for evaluating the break even
point. It is the point where cost of investment and cash flows generated from investment are
equal. Company earns profit after reaching the break even point. It cannot earn profit until the
cost of investment is covered of the project. Project with long payback period is not considered
by the management as it will not be able to earn profits on the investments (Ndanyenbah and
Zakaria, 2019). It is a simple and easy method used for evaluating the viability of project.
Investors use this method for assessing whether they will be able to earn the profits within the
life of investments of not. The method does not involve complex calculation of cost of capital.
However the method does not consider the time value of money in measuring the payback
period. The cost of investment will be recovered in 5 years and 4 months that shows payback is
adequate and it will earn profits from the investments after covering cost.
Accounting Rate of return
It is an investment appraisal technique which is used by the management and investors
for assessing the return that will be generated by the project or investments. It measures the
return from investments in terms of percentage. The investment method takes accounting profits
for computing returns on the investments. This is also called average rate of return which is
financial ratio used in the capital budgeting. It does not account for the concept of time value of
money like the IRR method. The method is used by the management when proposing the
determine the viability of existing operations or in acquisition of the new projects. It enables the
management and company to identify whether going ahead will be beneficial or not. A project
earning returns higher than 7% are considered profitable. If project yields profits lower than this
the projects should not be opted by the management or company (Wambua, and Koori, 2018). If
ARR is greater than or equal to required rate of return project should be accepted where it is less
than required rate project should not be accepted. Higher the ARR more attractive the
investment. ARR of the current investment is 19% which shows that the project is profitable and
should be accepted by the company.
Internal Rate of Return
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It is a metric used by the company for evaluating the profitability of the investments.
Internal rate of return is the discount rate which makes NPV of the cash flows as equal to zero in
the discounted cash flow analysis. Calculations of NPV are same as that of NPV. The method is
beneficial for the management as it provides investors to identify the return of the different
projects. While calculating the IRR initial investments are generally negative which depends
over the estimates of what project will be delivering in future. IRR is not the actual pound value
of project but is annual return which makes value of NPV equal to zero. The method is easy
calculating return in percentage terms. The method also covers time value of money which
makes the technique more reliable.
c) Non Financial Factors to be considered in the investments appraisal.
In proposed investments financial factors play a major and significant role and due to this
management identify the financial viability of the investment. Along with the financial factor
non financial factors play significant role in evaluating the viability of investments. There are
situations where the financial factor though feasible does not derive the required benefits if the
non financial factors are not adequate.
The non financial factors to be considered by the company evaluating the investments are
ensuring that company will be able to meet the current and the future legislations associated with
the investments. A company must be able to comply with the legal requirement of the
investments. If company is proposing to invest in any machine or plant, it is required to consider
the size of the plant. It involves that the project of the company is of required size and capacity to
meet the requirements of business. If the machine or plant is not able to meet the capacity
requirements of the company the investment may feasible will not be useful for the business. For
investment company may be required to strengthen the floors and walls to be spread rebuilt for
accommodating the equipment (Godbole and Jayraj, 2019). The possibility can have effect over
the cash flows and cannot be overlooked by the management.
Management is also required to ensure that the investments meet the required standards
for the proposed projects. The proposed investments should meet the required industry standards
and the god practice. Benefit of obtaining the similar equipment from the tested and tried
supplier could have profound consequences over financial analysis. Firm could make savings in
areas of the operative trainings inventory of spare parts and ease of maintenance. The
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maintenance requirements of the project should also be evaluated by the business as they have
significant influence over the cash flows of business.
The management should insect the machine in working environments to ensure that all
the functions are performed properly. Time should be invested to identify the ability of
operatives and the personnel involved with the equipments or machine is not neglected by the
company.
Human and social factors are also to be considered in the diverse and complex
environments. Objectives of the project will be achieved with the help of humans and therefore it
should ensure that people are motivated to work with the project and management has to ensure
that they are rewards for higher performance. For the success of the project firms are requires to
establish healthy relations with the community in which they will be operating.
Along with the new investment management is also required to provide timely training and
conduct development programs for developing capabilities of the business to achieve he goals by
building skills and the experience in the area of investments. It should strengthen its management
system for deriving maximum benefits out of the project. They have to anticipate and deal with
the future threats like protecting the intellectual property rights of the investments against
competition.
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REFERENCES
Books and Journals
Milenković, M., and et.al., 2016. Railway Investment Appraisal Techniques. In Handbook of
Research on Emerging Innovations in Rail Transportation Engineering (pp. 67-99). IGI
Global.
Ndanyenbah, T.Y. and Zakaria, A., 2019. Application of Investment Appraisal Techniques by
Small and Medium Enterprises (SMEs) Operators in the Tamale Metropolis, Ghana.
Wambua, P.M. and Koori, J., 2018. Investment Appraisal Techniques and Financial Performance
of Small and Medium Enterprises in Nairobi City County, Kenya.
Alkaraan, F., 2017. Strategic Investment Appraisal: Multidisciplinary Perspectives', Advances in
Mergers and Acquisitions (Advances in Mergers & Acquisitions, Volume 16).
Godbole, S.B. and Jayraj, G.K., 2019. PROJECT ECONOMIC APPRAISAL TECHNIQUES IN
CONSTRUCTION INDUSTRY-A COMPARATIVE STUDY.
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