Financial Appraisal of Project Investment: A Detailed Report

This report provides a comprehensive analysis of project investment appraisal techniques, focusing on the application of financial principles to evaluate and select the most viable investment options. The report begins by explaining key methods such as Internal Rate of Return (IRR), Accounting Rate of Return (ARR), Payback Period, and Net Present Value (NPV), crucial for assessing project profitability and risk. It then proceeds to evaluate three different projects (A, B, and C) using these methods, calculating net cash inflows, NPV, IRR, and ARR for each. The analysis includes detailed calculations and interpretations, highlighting the strengths and weaknesses of each project based on the appraisal results. The report culminates in a recommendation for project selection, suggesting the most financially sound option based on the findings. Furthermore, it discusses potential sources of finance for the selected project and outlines the components of working capital management necessary for successful project execution. The report is supported by relevant references, including books, journals, and online resources, providing a solid foundation for the financial analysis and recommendations.

Managing Financial Principles
and Techniques - 5 (Investment
Appraisal)

Table of Contents
MAIN BODY...................................................................................................................................1
A) Method of project Investment Appraisal................................................................................1
B) Evaluation of different project by investment appraisal.........................................................1
C) Recommendation for the selection of project.........................................................................4
D) Sources of finance...................................................................................................................4
E) Component of working capital ...............................................................................................4
REFERENCES................................................................................................................................6

MAIN BODY
A) Method of project Investment Appraisal
Internal rate of return : The IRR method is used for the capital budgeting to identify or
estimate the profitability of the company in particular accounting period (Pozzi and et.al., 2015).
It is used to calculate the expected return rate of the project or investment.
Accounting rate of return : It is used to identify the risk associated with the investment
or the project and help the investor to take the decision of investment in particular project.
Payback period : It refers to the time required by the company to recover the initial
investment or amount invested in the project (Harris, 2017.). Shorter pay back period refers that
the company financial position is good and asset make the good profit.
Net present value : It refers to the difference between the present value of cash inflow
and outflow in particular time period (Li and Trutnevyte, 2017). It is used to measure the
profitability of the project that weather the project is suitable for the company or not.
B) Evaluation of different project by investment appraisal
Calculation of net cash inflow for Project A
Project A
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
EBIT 2000 4000 5000 5000 5000 6400
Less
Depreciati
on 2167 2167 2167 2167 2167 2167
EAT -167 1833 2833 2833 2833 4233
Add
Depreciati
on 2167 2167 2167 2167 2167 2167
Cash
Inflow (in
£) 2000 4000 5000 5000 5000 6400
Calculation of net cash inflow for Project B
Project B
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
EBIT 4000 2000 2000 2000 1000 1000
Less
Depreciati
on 2167 2167 2167 2167 2167 2167
EAT 1833 -167 -167 -167 -1167 -1167
Add
Depreciati
on 2167 2167 2167 2167 2167 2167
Cash
Inflow (in
4000 2000 2000 2000 1000 1000
1

£)
Calculation of net cash inflow for Project C
Project C
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
EBIT 5000 5000 5000 3000 3000 2000
Less
Depreciati
on 2167 2167 2167 2167 2167 2167
EAT 2833 2833 2833 833 833 -167
Add
Depreciati
on 2167 2167 2167 2167 2167 2167
Cash
Inflow (in
£) 5000 5000 5000 3000 3000 2000
Calculation of Net present Value
Computation of NPV
Project A Project B Project C
Year
PV factor
@ 12%
Cash Inflo
(in £)
Discounte
d cash
Inflow (in
£)
Cash
Inflow (in
£)
Discounte
d cash
Inflow (in
£)
Cash
Inflow (in
£)
Discounte
d cash
Inflow (in
£)
1 0.893 2000 1785.71 4000 3571.43 5000 4464.29
2 0.797 4000 3188.78 2000 1594.39 5000 3985.97
3 0.712 5000 3558.90 2000 1423.56 5000 3558.90
4 0.636 5000 3177.59 2000 1271.04 3000 1906.55
5 0.567 5000 2837.13 1000 567.43 3000 1702.28
6 0.507 6400 3242.44 1000 506.63 2000 1013.26
Total
discounted
cash flow 17790.55 8934.47 16631.25
Initial
investment 13000 13000 13000
NPV(Total
discounted
cash
Inflow –
Initial
Investmen
t) 4790.55 -4065.52 3631.25
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Interpretation : As per the above calculation it can be concluded that project A is the
best option on the basis of NPV because it presents the positive NPV while project B shows
negative NPV. Project C also present the Positive NPV but lower than project A with the same
investment (Mahmoud and Neale, 2016).
Calculation of Internal rate of return
Computation of IRR
Project A Project B Project C
Year Cash Inflow (in £) Cash Inflow (in £) Cash Inflow (in £)
0 -13000 -13000 -13000
1 2000 4000 5000
2 4000 2000 5000
3 5000 2000 5000
4 5000 2000 3000
5 5000 1000 3000
6 6400 1000 2000
IRR 22.35% -2.83% 23.04%
Interpretation : As per the above table it can be interpreted that project C is the best
option for investment because it provides higher return among all the three project. The internal
rate of return of project C is 23.04%.
Computation of Average rate of return
Computation of ARR
Year Cash Inflow (in £) Cash Inflow (in £) Cash Inflow (in £)
1 2000 4000 5000
2 4000 2000 5000
3 5000 2000 5000
4 5000 2000 3000
5 5000 1000 3000
6 6400 1000 2000
Average cash inflow 4566.67 2000.00 3833.33
Average initial
Investment 13000 13000 13000
ARR 35.13% 15.38% 29.49%
Interpretation : According to the ARR method it can be analysed that the project A is
the best option of investment because it gives the higher average return among the three
investment plan (Wren, 2018). The average return from the Project A is 35.13%.
Calculation of Payback period
3

Computation of Payback Period
Project A Project B Project C
Year
Cash Inflow
(in £)
Cumulative
cash inflow
(in £)
Cash Inflow
(in £)
Cumulative
cash inflow
(in £)
Cash Inflow
(in £)
Cumulative
cash inflow
(in £)
1 2000 2000 4000 4000 5000 5000
2 4000 6000 2000 6000 5000 10000
3 5000 11000 2000 8000 5000 15000
4 5000 16000 2000 10000 3000 18000
5 5000 21000 1000 11000 3000 21000
6 6400 27400 1000 12000 2000 23000
Initial
Investment 13000 13000 13000
Payback
period 2.10 0.92 1.76
Interpretation: From the above calculation it can be concluded that project B is the right
choice for investment because it covers the initial investment of the project within the one year
while other project A & C covers the amount in 2.10 year and 1.76 Year respectively.
C) Recommendation for the selection of project
On the basis of the above calculation of NPV, IRR, Payback period and ARR it can be
recommend that Sensation Corporation has to select the project A for the investment. Project A
provides the highest NPV and Average rate of return while the Internal rate of return of the
project A is also good (Alkaraan, 2016). The project A is selected on the basis of NPV method
because it considers the time value of money while the other method ignore the time value of
money.
D) Sources of finance
Sensation corporation collect the finance from the different sources to invest in Project A.
They can collect the finance from the Own saving, borrow money from the friends and family,
take loan from Banks and private institutions such as corporate sector, money lender etc. They
can also raise the money from the Joint venture. All the sources of fund help the Sensation
corporation company to invest in the Project A and earn the profit (Abdel-Kader, Dugdale and
Taylor, 2018).
E) Component of working capital
Working capital refers to the difference between the current assets and current liability of
the company. The different component of working capital are :
4

 Cash
 Account receivables
 Account payables
 Inventory etc.
Sensation corporation have to manage the working capital of Project A to get the higher
profit to fulfil the day to day requirement of company. They have to control the current assets
and current liability to get the efficient working capital (Components of Working Capital
Management, 2019). The budgetary control method will help the company to monitor and
control the inventory level in the organisation which help to manage the current assets. They also
have to regulate the account receivable/ payable cycle receive or pay the debt on time.
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REFERENCES
Books and Journals
Harris, E., 2017. Strategic project risk appraisal and management. Routledge.
Mahmoud, O. and Neale, B., 2016. Managerial judgment factors and the real options approach in
the investment appraisal process: evidence from UK automotive firms. International
Journal of Business and Social Science, 7(5). pp.71-84.
Alkaraan, F., 2016. Strategic investment decision-making–Scanning and screening investment
opportunities: The expansion of Guinness in West Africa. Meditari Accountancy
Research, 24(4). pp.505-526.
Abdel-Kader, M.G., Dugdale, D. and Taylor, P., 2018. Investment decisions in advanced
manufacturing technology: A fuzzy set theory approach. Routledge.
Wren, A., 2018. Project Management AZ: A Compendium of Project Management Techniques
and How to Use Them: A Compendium of Project Management Techniques and How to
Use Them. Routledge.
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.
Pozzi, R., and et.al., 2015. Using simulation for reliable investment appraisal: evidence from a
case study. International journal of operational research, 23(1). pp.45-62.
Online
Components of Working Capital Management. 2019. [Online]. Available through :
<https://wikifinancepedia.com/finance/financial-management/components-of-working-capital-
management>.
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