Investment Appraisal.ppt

Investment Appraisal Investment Appraisal Investment Appraisal A means of assessing whether an investment project is worthwhile or not Investment project could be the purchase of a new PC for a small firm, a new piece of equipment in a manufacturing plant, a whole new factory, etc Used in both public and private sector Investment Appraisal Types of investment appraisal: Payback Period Accounting Rate of Return (ARR) Internal Rate of Return (IRR) Profitability Index Net Present Value (discounted cash flow) Investment Appraisal Why do companies invest? Importance of remembering investment as the purchase of productive capacity NOT buying stocks and shares or investing in a bank! Buy equipment/machinery or build new plant to: Increase capacity (amount that can be produced) which means: Demand can be met and this generates sales revenue Increased efficiency and productivity Investment Appraisal Investment therefore assumes that the investment will yield future income streams Investment appraisal is all about assessing these income streams against the cost of the investment Not a precise science! Payback Period Payback Method The length of time taken to repay the initial capital cost Requires information on the returns the investment generates e.g. A machine costs ￡600,000 It produces items that generate a profit of ￡5 each on a production run of 60,000 units per year Payback period will be 2 years Payback method Payback could occur during a year Can take account of this by reducing the cash inflows from the investment to days, weeks or years Days/Weeks/Months x Initial Investment Payback = ------------------------------------------ Total Cash Received Payback Method e.g. Cost of machine = ￡600,000 Annual income streams from investment = ￡255,000 per year Payback = 36 x 600,000/765,000 = 28.23 months (2 yrs, 6? months) Accounting Rate of Return Accounting Rate of Return A comparison of the profit generated by the investment wit