Investment Appraisal Measures and ROI Analysis for RT plc Options

This report critically analyzes various investment appraisal measures, including Accounting Rate of Return, Payback Period, Net Present Value, and Internal Rate of Return, to recommend the best investment option for RT plc. It discusses the usefulness and limitations of each method, ultimately suggesting Option A20 based on its lower initial investment, shorter payback period, and higher Internal Rate of Return. The report also explains the finance director's confidence in the IRR exceeding 7% due to the positive Net Present Value of both options. Concluding that while each method has its merits, Net Present Value offers a comprehensive approach to decision-making, this solved assignment is available on Desklib for students.

INVESTMENT APPRAISAL
AND RETURN ON
INVESTMENT

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................3
REFERENCES................................................................................................................................4

INTRODUCTION
Investment appraisal is a process of analysis of various investment projects to identify
and consider the profitability of an investment over the life of the assets. The present report will
critically discuss the usefulness of various investment appraisal measures and recommendation
on one option out of two using result of different measures. Further, the report will discuss why
the finance director of RT plc was so confident that IRR would be greater than 7% in the case of
both option. Lastly, the report will conclude which option would be best along with which
investment appraisal would be more useful for decision-making.
TASKS
Q.1 Critical discussion on the usefulness of the respective capital investment appraisal measures
Accounting rate of return
Accounting rate of return is a simple measure that can be used to calculate a rate of return
that is expected on the investment. It is one of the simplest methods of evaluating an investment.
This method makes use of the available accounting data and provides a true analysis of the
performance of the company. It does not use cash flow statements. It takes into account the each
and every aspect of the income statement and provides a clear image of the profitability of the
company (Fortaleza, Neto, and Miranda, 2020.). However, as this method ignores the use of
cash flow statement and considers only the income statement of the company while calculating
the returns on investments, it might lead to inaccuracies in the resulted figures. This method
completely ignores the aspect of time value of money and do not recognise various outside
determinants which might affect the profitability of a project. This could lead to a number of
discrepancies in the calculated rate of return.
Payback period
This method is very convenient for the use of managers in making quick decisions as it
requires only a few factors to be considered in order to make the necessary calculations. It
provides small businesses with the information that they need to quickly recover the cost of
investments and plough the money into other prospects in order to reduce the risk of non-
payment. This method is advantageous for those companies that face rapid changes due to the
technological advancements as it helps them in identifying those projects which have a short

payback period (Gaspars-Wieloch, 2019.). Be that as it may, but it ignores a number of factors
which are considered necessary for the precise evaluation of the payback period of an
investment. These include ignoring the time value of money and profitability aspect, not
considering all cash flows, and not being realistic. The time value of money is an important
factor which should be considered as it states the importance of the money that is received early
due to its capability of providing additional returns if put it in other prospects.
Net present value
Net present value is technique of capital budgeting which helps a company in identifying
the feasibility of a project. This technique can be found useful and provide an accurate view as it
considers the time value of money, risk factors, cost of capital, all cash flows and helps a
company with decision-making. This method understands that the value of a dollar today holds
much more importance than its value tomorrow owing to earning size (Kengatharan, 2018).
However, NPV has its own set of disadvantages too. It does not allow a company to compare
projects of different sizes. Therefore, the NPV of big projects will be higher than the smaller
ones. Another drawback of NPV method is that it does not have any set rules and guidelines to
calculate the required rate of return.
Internal rate return
This measure of capital investment appraisal incorporates the use of time value of money
by equating the present value of cash flow with the required capital investment. It includes a
system through which projects can be ranked as per their profitability. Conversely, IRR provides
an incomplete picture related to the future of the company as its calculation does not involve the
cost of capital (Sampaio Filho, Vellasco, and Tanscheit, 2018.). This method ignores the future
costs during the process of calculation. IRR also overlooks the overall extent and scope of the
project.
Recommendations
The company RT plc should go ahead with the option A20. This is so because after
comparing both the options, it can be stated that the initial investment under this option is less
than the option B25. Further. It can be observed that the payback period of the option A20 is less
than the other option, due to which the company will be able to recover the invested amount in
shorter duration. The Internal rate of return under option A20 is higher than the option B25
which mean the rate of return under option A20 will prove to be more beneficial for the

company. All of these factors are acting the favour of option A20, therefore the company should
choose option A20.
Reasons due to which the finance director was so confident that IRR would be well in excess of
7 % for both options.
Under the following situation, the cost of capital is given as 7% and the net present value under
both the options A20 and B25 have also been given. Under both the options, the net present
value of the given projects is positive. The net present value of a project can only be positive
when the present cash inflows are higher than the present cash outflow. Under this given
situation, the finance manager is confident that the IRR will be greater than 7% for both the
options because the given NPV under the given options is positive. The positive NPV is an
indicator that the IRR would be above the cost of capital which is given as 7%. Because, positive
NPV can also be achieved when the IRR is greater than the cost of capital.
Conclusion
From the above report, it can be stated that each and every method of capital appraisal
has its own set of advantages and disadvantages. But, according to this study, it can be said that
the Net present value method of capital appraisal is one of the best measures as it takes into
account all the relevant factors while carrying out the process of calculation. Further, the study
provides a recommendation to the RT plc as to consider option A20 as it is more beneficial for
the company.

REFERENCES
Books and Journals
Fortaleza, E.L.F., Neto, E.P.B. and Miranda, M.E.R., 2020. Production optimization using a
modified net present value. Computational Geosciences. 24(3). pp.1087-1100.
Gaspars-Wieloch, H., 2019. Project net present value estimation under uncertainty. Central
European Journal of Operations Research. 27(1). pp.179-197.
Kengatharan, L., 2018. Capital Budgeting Theory and Practice: A review and agenda for future
research. American Journal of economics and business management. 1(1). pp.20-53.
Sampaio Filho, A.C.D.S., Vellasco, M.M. and Tanscheit, R., 2018. A unified solution in fuzzy
capital budgeting. Expert Systems with Applications. 98. pp.27-42.
Sarwary, Z., 2019. Capital budgeting techniques in SMEs: A literature review. Journal of
Accounting and Finance. 19(3). pp.97-114.
Siziba, S. and Hall, J.H., 2021. The evolution of the application of capital budgeting techniques
in enterprises. Global Finance Journal. 47. p.100504.