Analyzing Investment Appraisal Measures for Optimal Project Selection

This report delves into capital budgeting and investment appraisal techniques, essential for businesses in selecting optimal project plans. It evaluates methods like discounted payback period, profitability index, net present value, accounting rate of return, and internal rate of return to determine which project yields the highest returns and quickest recovery of initial investments. Focusing on RT Plc's Project A20 and Project B25, the analysis recommends Project A20 based on its superior internal rate of return and shorter payback period. The report also justifies the finance director's confidence in both projects exceeding a 7% IRR, citing strong NPV and average rates of return. Ultimately, it highlights the importance of capital budgeting for managing accountability, assessing long-term profitability, and guiding investment decisions, emphasizing the need for a strategic approach to project selection to ensure efficient functioning and investor confidence. Desklib provides access to similar reports and study resources.

Investment Appraisal
and Return on
Investment

Table of Contents
INTRODUCTION...........................................................................................................................3
TASK...............................................................................................................................................3
Q1. Describe the usefulness of capital investment appraisal measures and provide
recommendations as which option must be chosen................................................................3
Q2. Define reasons why finance director was so sure that IRR would be more than 7% for
both options............................................................................................................................5
CONCLUSION................................................................................................................................6
REFERENCES................................................................................................................................7

INTRODUCTION
The report prepared explains capital budgeting which helps a business to understand
which project plan or investment plan it must choose. It involves various appraisal techniques
available in the market and choose among them which would fit the requirements in best
possible manner. It helps to find which project will generate more revenues and will recover its
initial investment better than others. It guides managers to understand the cash inflow and
outflow taking place in a company during the year and how risks can be controlled in due time
(Bianchi, Rossini and Iacopini, 2020).
TASK
Q1. Describe the usefulness of capital investment appraisal measures and provide
recommendations as which option must be chosen.
Capital budgeting/ investment appraisal focuses on taking decisions as which project
must be given preference and should be chosen. It also prioritizes on achieving goals, objectives
set by the organisation. It is important for the business because it manages accountability and
measurability which helps to measure risks prevailing with the project plans and which accounts
are accountable for which expenses/ incomes. Investment appraisal is the analysis which is
helpful in calculation of profit margin and also testing affordability of project. Net present value
helps to evaluate the difference between revenue generated and expenses incurred over a period
of time in firm (Ahmad and et.al., 2021).
Investment appraisal techniques explained below:
Discounted pay back period: It can be explained as a process which helps to predict profitability
in a certain area. It helps to determine time value of money and cover the initial investment done
by business in a project.
Profitability index: It is a measure helpful for calculating cash flow which takes place in a
business. It can be explained as cash generated or cash spent by a company over a period of time
and what is the profit earned. It helps to assess various projects at one point of time and find out
if investment done in a project by business is helpful for future perspectives or not.
Net present value: It can be explained as a method which is useful to find out whether initial
investment made by business and present value earned is covering all expenses or not. It is useful
in conditions where cash flow activity is recorded at different time intervals.

Accounting rate of return: It is a technique which is helpful in finding urge to earn profit on
investment made for a period of time. It is important as it guides investors to examine the risk
involved in investment and make a decision whether the investment made is worth the risk.
Internal rate of return: It can be explained as a method useful in analysing finance related areas
to estimate what would be the revenue generated from investment made in project. IRR observed
in RT Plc company for Project A20 is 10.9% and in case of Project B25 is 9.5%. Thus It can be
said that for the long life cycle of company Project A20 would prove to be more helpful. (Chen
and et.al., 2019).
Payback period: It can be defined as time taken to cover costs related to investment made in a
project. Thus observed payback period in RT Plc company is 3.67 years in case of Project A20
and 4.17 years for Project B25. It therefore, states that plan A would prove to be more beneficial
for company the reason being it will take less time to cover investments made by investors,
corporates and financial professional in the company. This will also increase reputation and
brand image of business in market.
Importance of Capital budgeting techniques:
 Capital budgeting is necessary because it helps to manage accountability and
measurability.
 It is a way which helps business to understand long term financial profitability of every
investment project.
 It is a commitment towards both financial as well as in investment area too. It also guides
firm to evaluate investment proposal in order to help them chose which project would be
more desirable and generate revenues.
Recommendations for the project:
Net present value: Net present value can be explained as significant difference observed between
present value of cash generated and cash used or invested for a certain time duration. In above
situation this method would be helpful for choosing among two projects laid. The plan can only
be selected when the present value of future inflow is higher than initial investment. In the above
situation project A20 will be selected because investment made is less than other project but
payback period is observed less than the other project which clearly states that less time will be
required for covering the investment made.

Accounting rate of return: This technique is helpful in finding profitability on long term basis
keeping business concerns in mind. If the profit generated by business is high than the
Accounting rate of return would also rise. When compared with Project A20 it can be observed
that Project B25 is providing higher rate of return which is 15% and thus Project B25 would be
selected.
Payback period: It is defined as a period during which the amount invested in a particular project
is recovered. With the help of this technique it can be analysed that Project A20 took 3.67 years
for covering its investment made in initial stages whereas Project B25 took 4.17 years. Thus it
can be concluded that Project A20 should be selected.
Internal rate of return: This method is useful to have a proper analysis of financial areas which
help to calculate what could be estimated profits of investments made. It also helps to examine
which project gives higher rate of interest on investments made by the business. Thus keeping
this in mind Project A20 is beneficial and must be selected because it generates more return than
Project B25 (Brück, Ludwig and Schwering, 2018).
From the above applied techniques such as Internal rate of return, accounting rate of
return, Net present value it can be said that Project A20 must be selected because it is given more
priority than any other project. Project A20 is providing positive Net present value, Payback
period observed for Project A is 3.67 years which is less than Project B25 that is 4.17 years.
Internal rate of return is 10.9% in case of Project A20 whereas 9.5% in case of Project B25. Thus
it is evident that Project A20 will prove itself to be more worthy than other project.
Q2. Define reasons why finance director was so sure that IRR would be more than 7% for both
options.
The finance director confidently stated that IRR under both the options will be more than
7%. The reason for such statement can be as under:
 The NPV under both the options is more than £ 100000 and the amount invested is £
1000000 and £ 1300000 respectively under both options which directly signifies that RT
plc is earning more than 10% under both the projects.
 The average rate of return comprises of average past profits which is again greater than
13% that directly signifies strength and earning capacity under both the options.
 IRR indirectly denotes the earning capacity and under both the options financial
techniques applied such as NPV and ARR reflecting the results more than 7 %.

 There is another interpretation that industry under which RT Plc is working assumes
return of above 7% on investment they made in projects under consideration that is the
reason director finance is confident that IRR will be more than 7%.
CONCLUSION
From the above prepared report, it can be concluded that there are many projects which
would suit requirements of a business but there are some which are beneficial for the firm. Thus
it is important to choose best from the available options. It is helpful to understand what are
techniques that can be applied to find out which project company must chose considering
previous year performance. This report helps to predict future conditions which would be useful
for managers in forming plans for efficient functioning and running of company. It also serves as
a guide for investors and analysts to understand where the project lacks and how those areas can
be looked after. It also helps customer's to have an idea about positioning of company in market
and its strong as well as weak areas too.

REFERENCES
Books and Journals
Bianchi, D., Rossini, L. and Iacopini, M., 2020. Stablecoins and cryptocurrency returns:
Evidence from large bayesian vars. Available at SSRN 3605451.
Ahmad and et.al., 2021. Can innovation shocks determine CO2 emissions (CO2e) in the OECD
economies? A new perspective. Economics of Innovation and New Technology. 30(1).
pp.89-109.
Chen and et.al., 2019. Investment decision on shallow geothermal heating & cooling based on
compound options model: a case study of China. Applied Energy. 254. p.113655.
Brück, C., Ludwig, J. and Schwering, A., 2018. The use of value-based management in family
firms. Journal of Management Control. 28(4). pp.383-416.
Pandharipande, A. and Newsham, G.R., 2018. Lighting controls: Evolution and
revolution. Lighting Research & Technology. 50(1). pp.115-128.