Basic Investment Appraisal Techniques PDF

Basic investment appraisal techniques Capital Assets Investment Cycle Steps 01 02 03 04 05 Capital Budgeting...

Basic investment appraisal techniques Capital Assets Investment Cycle Steps 01 02 03 04 05 Capital Budgeting Cycle Steps Identifying Screening Analysing Approving Implementing investment investment and investment monitoring opportunities proposals evaluating proposals and investment reviewing proposals investments. Financial Evaluation Methods ; 01 02 03 04 ROCE PAYBACK NPV IRR  Return on capital Employed / Accounting Rate of return The Average return of a project expressed as a percentage of the initial capital investment or average investment Return on capital Employed / Accounting Rate of return Decision rule If ARR of the project > Target ARR then Accept the project. Else Reject the project.  Advantages Disadvantages Expressed in terms familiar to managers – profit and No account is taken for difference in life of mutually capital employed. exclusive projects Easy to calculate Ignores the time value of money Links with other accounting measures It varies depending on accounting policies Payback Period Time period required to Payback recover the method is initial based on investment cashflow If Payback Period < Target Payback, Accept the Project.  Advantages Disadvantages It is simple to use (calculate) and easy to understand Does not give a measure of return It helps to maximise liquidity Ignores time value of cash flows The method is often used as the first screening Ignores cash flows after the payback period. device to identify It is subjective – no definitive investment decision. Accounting profits and cash flows Profits cannot be spent Profits are subjective Cash is required to pay dividends. Relevant Cash flows For all methods of These are: Ignore: investment appraisal, with the  Future  Sunk costs exception of ROCE,  Incremental  Committed costs only relevant cash  Cash-based.  Non-cash items flows should be  Allocated costs. considered or Opportunity costs. Assumptions on Timing of Cashflows 1. If Cash flows arise during the period, then it is assumed as it arises at the end of that period. 2. If cash flow arise at the start of the period then it is assumed as if it arises at the end of the preceding period 3. Period ‘0’ is not a period, instead it represents start of period ‘1’.