Investment appraisal should add value to business entity - Free Essay Example

Sample details Pages: 6 Words: 1866 Downloads: 4 Date added: 2017/06/26 Category Business Essay Type Argumentative essay Did you like this example? Successful companies are always keen to develop and grow by investing in the new projects to sustain and maintain their strategic position in the competitive market. Therefore companies always adopt strategic planning approach also known as corporate planning for long-term which in result gives direction to the company. One of the key areas in Strategic planning is strategic decision making by the senior management, to manage the available funds by the firm , right choice of investments by using strategic analysis approach and considering whether the options meet and are consistent with the firms objectives and are acceptable to main stakeholders.. Don’t waste time! Our writers will create an original "Investment appraisal should add value to business entity" essay for you Create order Financial Management analyse their available options of investments by focusing on the size of the funds need to commit to purchase lands, buildings etc, expected inflows and outflows in the future, life span of the investment and degree of risk involved in the investment. Then the management select the best possible options which are economical and profitable for the firm. This approach is known as investment appraisal. The investment appraisal process is concerned with assessing the value of future cash flows compared to cost of investment. The above discussed investment appraisal approach also contributes and on the following aspects of the business. Replacing the obsolete assets with newly developed assets. Enhancement of current products and development of new products. Increase in existing market share and introduction of new markets. Objective based fair decision making by analysing all possible alternatives Investments in profitable projects which adds value to the business. Realistic budgeting and cash flow forecasting. Considers risk involved in the projects. Therefore it can be clearly seen that Investment Appraisal approach in decision making also adds value to the Business along with selecting the most economical and profitable choices for the business in long term. Calculate payback period, NPV and IRR for each project. For each of the above methods which projects should be selected and explain why? Payback Period Method Project A Project B Year Net Cash flow Cumulative Cash flow Net Cash flow Cumulative Cash flow 0 (10,000) (10,000) (25,000) (25,000) 1 3,000 (7,000) 6,500 (18,500) 2 3,000 (4,000) 7,000 (11,500) 3 3,000 (1,000) 7,500 (4,000) 4 3,000 2,000 7,500 3,500 5 3,000 5,000 8,000 11,500 Payback period 3.33years 3.53years The above results shows that payback period of initial outlay of project A is 3.3 years which means 3 years and 4 months whereas the payback period of investments of project B is 3.5 years which means almost 3years and six months and in longer than project A, therefore projects A is more feasible compare to Project B in terms of payback of initial investment. Net Present Value Project A Year Cash flow DF @ 12.5% Present Value 0 (10,000) 1.000 (10,000) 1 3,000 0.889 2,667 2 3,000 0.790 2,370 3 3,000 0.702 2,106 4 3,000 0.624 1,872 5 3,000 0.555 1,665 NPV pound;680 Project B Year Cash flow DF @ 12.5% Present Value 0 (25,000) 1.000 (25,000) 1 6,500 0.889 5,779 2 7,000 0.790 5,530 3 7,500 0.702 5,265 4 7,500 0.624 4,680 5 8,000 0.555 4,440 NPV pound;694 Based on the Net Present Value calculation both projects have positive NPV and therefore will be suitable for the investments and will generate profits for the firm in future. We will therefore select to invest in project B because it has high NPV compare to project A. Internal Rate Of Return Project A Year Cash flow DF @ 10% Present Value 0 (10,000) 1.000 (10,000) 1 3,000 0.909 2727 2 3,000 0.826 2478 3 3,000 0.751 2253 4 3,000 0.683 2049 5 3,000 0.621 1863 NPV @ 10% pound;1,370 IRR= 10+ 1370 x (12.5-10) 1370-680 14.96% Project B Year Cash flow DF @ 10% Present Value 0 (25,000) 1.000 (25,000) 1 6,500 0.909 pound;5,909 2 7,000 0.826 pound;5,782 3 7,500 0.751 pound;5,633 4 7,500 0.683 pound;5,123 5 8,000 0.621 pound;4,968 pound;2,414 IRR= 10+ 2414 x (12.5-10) 2414-694 13.51% As indication from the above results of IRR, Project A would be accepted by project manager and potential investors. In both projects, cost of capital is same i.e. 12.5% but IRR of project A is 14.96% compare to 13.51% of project B. As per general rule, if resulted IRR is more than the interest rate then it should be acceptable but in our given scenario we will invest in project A because it has more difference between IRR and its cost of capital compare to project B. D) Explain why it is essential that discounted cash flow should be calculated when making Long Term Investment decisions. Discounted cash flow analysis is a procedure whereby the value of future cash flows are discounted back to present values using the discounted rate based on the cost of the capital available for the project, so that the economic values of future cash flows are comparable despite of timing difference. In the dearth of discounted future cash flows, resulted NPV and IRR will not appraise the project in real term and will not reflect the true picture of the investment appraisal. The key idea behind is that the value of money decline over time period due to the impact of inflation factor in eroding spending power. Investors normally like to receive their money back as soon as possible because it creates opportunities to invest new and upcoming ventures. In contrast, short term investment for instance the project for the year or less, the cash flows do not need to discount back and not require dealing with inflation .It is therefore essential to discount the cash flow so the impact of inflation and taxation on cash flows can be incorporated in projecting long term investments. E) What would happen to the NPV if; The cost of capital increased The cost of capital decreased The Net Present Value uses discounting to compute the present value of all future cash flows linked with the project The Net Present Value rely on the cash flow pattern and cost of capital which is applied. Any changes in the cash flows or in cost of capital will directly affect the resulted NPV and therefore project implementation as well. If cash flows are stagnant and cost of capital is variable then NPV will be indirectly proportional to the cost of capital. . If cost of capital increases, it affects discount factor and present value of future cash flows will decrease resulting lower NPV until reaches to negative NPV in which case investment of project will be rejected. If the cost of capital decreases then NPV will increase as can be seen in the following illustration on given date of Project B. Project B Year Cash flow PV @ 10% PV @ 12.5% PV @ 15% 0 (25,000) (25,000) (25,000) (25,000) 1 6,500 5,909 5,779 5,649 2 7,000 5,782 5,530 5,292 3 7,500 5,633 5,265 4,928 4 7,500 5,123 4,680 4,290 5 8,000 4,968 4,440 3,832 pound;2,414 pound;694 (pound;1,010) F) Explain why the NPV of relatively long term project is more sensitive to change in cost of capital than is the NPV of a short term project. One of the drawbacks of using NPV as capital budgeting specially for long term project is to accurately calculate discount rate for the project life. The NPV based on the estimated future cash flows which are to be discounted back to their present value by using discount rates whereas investments do not need to discounted because of time 0 .Also during calculating NPV of the project there can be multiple key variables which would be sensitive and the smallest changes produces the biggest results in project NPV. In reality project may have several variables which can be affected the resulted NPV and are sensitive for the project but if we concentrate and observe only the discount rate in isolation we can find that even minor change in discount rate can either adversely affect or improve the resulted NPV of the project. Therefore to select an appropriate interest rate is quite significant In the above table, we can observe as discount rates changes from 10% to 15%, the resulted NPV also changes from positive pound;2,414 to negative pound;1,010 which will not be acceptable to investors. The interest rate used for discounted should be equal to required rate of return which means that if investments would have invest to best available project or lower cost of financing .To establish effective and stable discount rate for long term projects hardly is an exact science. In real term discount rate may vary every year or even change during the year due to inflation and risk. In short term projects, inflation and risk factors do not affect a lot to interest rate comparatively in long term projects where these can affect the interest rate for each year. If we incorporate the different discount rates for each year this made NPV more complex model so lower rate of interest would be more appropriate to the extent that a long term project implies secure income stream. G) How does change in cost of capital affects the projects IRR? IRR uses discounting in a slightly different way to determine the profitability of an investment. The IRR is defined as the discount rate at which NPV value equals zero. For example in Project B, an investment yields net present value of pound;694 when discounted as 12.5 %. When we reduced the rate of interest to 10% then the resulted NPV rise to pound;2,414 and IRR was 13.51% which depicts the efficient and break even interest rate for the investment. As per general rule, IRR should be more than the discount rate then the company should invest in the project. Project B Year Cash flow PV @ 10% PV @ 12.5% PV @ 15% 0 (25,000) (25,000) (25,000) (25,000) 1 6,500 5,909 5,779 5,649 2 7,000 5,782 5,530 5,292 3 7,500 5,633 5,265 4,928 4 7,500 5,123 4,680 4,290 5 8,000 4,968 4,440 3,832 pound;2,414 pound;694 (pound;1,010) IRR= 10+ 2414 x (12.5-10) 2414-694 13.51% IRR= 10+ 694 x (15-12.5) 694+1010 15.40% As it is evident in the above calculation that if discount rate changes to then resulted IRR also changes. At 12.5% and 10% discount rates IRR is 13.51% compare to IRR of 15.40% when uses NPV by discounting at 12.5 % and 15% . In both cases IRR is higher than the discount rates and is acceptable for the project. But margin of change in interest rate second scenario is only 0.40% which can be highly risky in volatile market. h) Compare the effectiveness of NPV method with that of IRR method. There are different approaches in capital budgeting which can be used which can used investment appraisal. NPV and IRR are most popular approaches and two faces of same coin and but there are some key limitations in both approaches. The investment on the project is accepted if NPV is greater than zero after ranking NPVs of all the projects and normally provide clear indication whether to accept or reject the project whereas IRR is accepted if it is greater than cost of capital, both approaches gives different results. NPV gives result in real term means in currency whereas IRR is represented in percentage which is easy for project managers to compare with required rate of return , interest rare and inflation rate. IRR percentage can also use for managerial appraisal during divisional performance. Research also shows that NPV approach is preferred to IRR because it also incorporates and calculates additional wealth which IRR does not cover. IRR also does not give the freedom to discount the cash flows at different discount rates which is possible in the case of NPV method. If cash flows are fluctuating and inconsistent, IRR does not seems to be conclusively applicable in these circumstances where as NPV method would pose no challenge to this problem as it will take the net effect of all cash outflow and inflow and will provide the average return of the investment NPV and IRR both are difficult in the context of to estimate the accurate discount rate to use. This leads problem towards risk premium which affect the riskiness of the project. Therefore alternative approaches of investment appraisal should also be considered like sensitivity analysis, profit. In small projects Net Present Value and IRR does not generally employed. Normally projects involves variety of risks and different methods are used which gives better understating regarding the returns of investments and practical benefits of IRR and NPV calls into question and put some practical limitation in use of these methods.

Social Networking Affects Our Youth - 939 Words

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Book Report Build A Better Barn ! - 2043 Words

Book to Brief: Build a Better Barn! TED 775- Integrating Technology in Elementary/Middle School STEM Curriculum Olivia Hippensteel Due Date 6/26/16 Children’s Literature Connection: Otis and the Tornado By: Loren Long Teacher Information: Problem to be solved: In the story, a tornado hits and the farmer and his family seek shelter underground. Unfortunately, there wasn’t time to help the animals. Otis and his animal friends gathered into Mud Creek, the lowest part of the farm and were safe. At the end, they find the barn destroyed and they rebuild it. How can the barn be rebuilt so that it can withstand a tornado and the animals can be safe inside? Design Challenge: Build a Better Barn! Students will use steps of the†¦show more content†¦One day out of nowhere the sky turned dark and stormy and a tornado appeared. The farmer and his family sought shelter in the cellar but there wasn’t time to help the animals. Otis freed the animals and took them to safety in Mud Creek. Otis can hear the bull crying from its pen and quickly goes back to save him. Otis and the Bull hide in Mud Creek with the other animals until the storm is over and return to their barn, which has been destroyed by the tornado. Together, Otis and all of the animals, even the Bull, rebuild the barn. †¢ Book Read Aloud: https://youtu.be/fKwautnw3vA †¢ The Engineering Design Process: http://www.sciencebuddies.org/engineering-design-process/engineering-design-process-steps.shtml#keyinfo Lesson Standards: ITEA (Grades 3-5): Standard 1: Students will develop an understanding of the characteristics and scope of technology. In order to comprehend the scope of technology, students should learn that: D. Tools, materials, and skills are used to make things and carry out tasks. Standard 2: Students will develop an understanding of the core concepts of technology. In order to comprehend the core concepts of technology, students should learn that: H. Resources are the things needed to get a job done, such as tools and machines, materials, information, energy, people, capital, and time. J. Materials have many different properties. L. Requirements are the limits to designing or making a product or system. Standard 7:

Competing Values Embedded In The Management-Myassignmenthelp.Com

Question: Discuss About The Competing Values Embedded In The Management? Answer: Introducation The capital budgeting processes consists of the several techniques for the explanation and the projection of the cases. The table that has been constructed in the question above reveals that the net present value process has been exploited in order to predict the future cash flows in accordance to the project. The various other techniques are inclusive of the average rate of return and the payback period that can be utilised for predicting the risks that are related with the project. By having a look at the table above, it can be clarified that the net present value has been observed to be optimistic and the index of profitability of the project has been 191.89%. The net present value being positive unveils that the project is doable and the organization should activate their investment operations. The cost benefit ratio of the project is figured by taking help of the profitability index and for this scenario the value has accounted for 191.89% and in this manner demonstrating that the present value of the future cash flows is more than the amount that has been primarily invested by the company. The other data regarding the dismissal and the acknowledgment of the project can be embraced with the assistance of the incorporation of different techniques of capital budgeting like the payback period and the average rate of return. The financial statement has been developed so as to understand the matters regarding the capital structure of APN Outdoor Group, a company that is enlisted in the ASX. The financial statement has clarified the calculation of the weighted average cost of capital and the evaluation of the crucial financial ratios of the organization. Evaluation of APNs Capital Structure The WACC of APN Group has been accounted for 8.32%. An additional fund of $181.8 of equity was maintained by APN in the year 2016 for the development of the new capital structure. The organization hopes to bring down the cost of capital with the assistance of maintaining the most precise capital structure. With the help of the assessment of the annual financial report, it can be proposed that during the financial year of 2016, the proportion of debt in the capital structure has declined. The cost of capital of APN can be diminished further by raising the amount of the proportion of debt in their capital structure. The reason has been the way that the equity capital that has been disclosed and thereby has increased the interest bearing liabilities, which has diminished in the present year (Sawabe 2013). Therefore at the conclusion, it can be explained that the equity value has stayed at 38.1 in the current financial year and the general debt to capital has valued to 27.61. Evaluation of the financial ratios of APN APNs net operating cash has diminished during the last three financial year and the per share earnings of the company has been 19% lower to the target because of the present policies and the value summed up to 0.29 in the current year. The income per share has fallen significantly to 31.4 in the year 2016, which were earlier 44.4 in the year 2015. The price earnings ratio has been valued to 16.92 in the year 2017. The liquidity evaluation scenario of APN is embraced by viewing the quick, cash and the current ratios. The cash ratio of APN has been 0.38, the quick ratio has been figured to be 1.89 and the current ratio has been valued to 1.90. The interest coverage ratio has been found to be 25.96 and the debt to total asset has been found to be 0.23. APN Outdoor and the performance of its competitors Ooh Media has been discovered to be one of the significant competitors of APN Group. The capital structure of the organization is a comprehensive blend of the equity and the borrowings. The equity capital amount gets increased alongside the borrowings and thus it can be clarified that APN's capital structure is a blend of the debt and equity. There has been a change in the capital structure of APN throughout the previous three years and they have not been dependent on the loan and borrowing of equity financing. Henceforth, it can be said that the capital structure of both the organizations is a blend of financing their assets. The organization, APN Outdoor Group has established a vigorous cash flow that aids in funding the investments and establishes suitable returns for the stakeholders. Capital Structure of APN Outdoor group The capital structure of an organization is a blend of the equity and debt with the purpose of funding the asset. Cost of capital has been found to be the rate of return that is foreseen by the organization on the earnings over the capital as an alternate amount of funding alongside the availability of risk (Averin et al., 2016). The changes in the capital structure directly affect the weighted average cost of capital. Subsequently, in order to increase the market value, it is essential for the company to bring down their cost of capital. The cost of capital of an organization can be brought down with the assistance of redesigning their capital structure and it is to be observed that the cost of capital does not outperform the expected rate of return. The cost of capital being lesser would make investment in the new projects inexpensive. Conclusion The evaluation of the situations that have been discussed earlier in this report, it can be described that the capital structure of APN Outdoor Group comprises of the equity and the debentures. They have been providing suitable returns to their shareholders and hence the company has been paying higher level of dividends to their shareholders. The revenue and the earnings before tax and the interest of the organization has been seen to have an upward trend that in a way has provided satisfactory returns to the shareholders. Reference List Averin, O. I., Kolesnik, N. F., Makarova, L. M. (2016). The Integration of the Accounting System for Implementing World Class Manufacturing (WCM) Principles. European Research Studies, 19, 53. Sawabe, N. (2015). Value-driven responsibility accounting-dynamic tensions generated by competing values embedded in the management control system (No. e-14-020).