Investment 1

7/17/2019 Investment 1

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Investment Appraisal


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A means o assessing whether anin!estment pro"ect is worthwhi#e or

not Investment project could be the

purchase of a new PC for a small firm, anew piece of equipment in a

manufacturing plant, a whole newfactory, etc

Used in both public and private sector


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Investment Appraisal $ypes o in!estment

appraisa#:

Paybac! Period

Accounting "ate of

"eturn #A""$ Internal "ate of

"eturn #I""$

Profitability Inde%

&et Present 'alue

#discounted cashflow$

(hat factors need to be considered beforeinvesting in equipment such as this)

Copyright* +ergely rno, stoc!-%chng


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%hy do companies in!est& Importance of remembering investment as the

purchase of productive capacity &./ buying stoc!s

and shares or investing in a ban!0 1uy equipment2machinery or build new plant

to* Increase capacity #amount that can be produced$

which means*

3emand can be met and this generates sales revenue Increased efficiency and productivity


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Investment thereforeassumes that theinvestment will yield

future incomestreams Investment appraisal

is all about assessingthese incomestreams against thecost of theinvestment

&ot a precisescience0

A for! lift may be an important item but whatdoes it contribute to overall sales) 4ow longand how much wor! would it have to do torepay its initial cost)

Copyright* 5oisjune, stoc!-%chng


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Paybac! Period


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Paybac! 6ethod

$he #ength o time taken to repaythe initia# capita# cost

"equires information on the returns theinvestment generates

e-g- A machine costs 7899,999

It produces items that generate a profit

of 7: each on a production run of89,999 units per year

Paybac! period will be ; years


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Paybac! method

Paybac! could occur during a year

Can ta!e account of this by

reducing the cash inflows from theinvestment to days, wee!s oryears

'ays/%eeks/(onths ) *nitia# *n!estment+ayback , ------------------------------------------

$ota# Cash ecei!ed


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Paybac! 6ethod

e-g-

Cost of machine = >

7=;G->> is what you would have toinvest today at a rate of interest ofH-;: to earn 7:99 in B9 years time

P's can be found through valuationtables #e-g- ParryFs 'aluation /ables$


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Cash Jlows


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3iscounted Cash Jlow

An e)amp#e:

A firm is deciding on investing in an

energy efficiency system- /wo possiblesystems are under investigation

.ne yields quic!er results in terms ofenergy savings than the other but thesecond may be more efficient later

(hich should the firm invest in)


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3iscounted Cash Jlow Eystem A

ear Cash #ow 184 'iscount actor

19.7;4

+resent a#ue

184

1C ) '4

9 D 899,999 B-99 D899,999

B K>:,999 9-G:H8:=G >B,:GG-9H

; KB99,999 9-GBB=8HB GB,B=8-HB

= KB:9,999 9-?>99=>H B=9,:9:-8B

H K;99,999 9-?=9:?H8 B88,BB8-G;

: K;B9,999 9->G;G;9G B88,:B=-=G

8 KB:9,999 9->:8G8:9 BB=,:HH->:

$ota# 2+ ,?@=9


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3iscounted Cash Jlow Eystem 1

ear Cash #ow 184 'iscount actor

19.7;4

+resent a#ue 184

1C ) '4

9 D 899,999 B-99 D899,999

B K;:,999 9-G:H8:=G ;=,?88-=:; K>:,999 9-GBB=8HB 8?,=:;-=B

= K?:,999 9-?>99=>H >=,G:=-B?

H KB99,999 9-?=9:?H8 ?=,9:?-H8

: KB:9,999 9->G;G;9G BB?,G=?-B98 KH:9,999 9->:8G8:9 =H9,8=H-=9

$ota# 2+9


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3iscounted Cash Jlow

ystem A represents the betterin!estment

Eystem 1 yields the same return aftersi% years but the returns of Eystem Aoccur faster and are worth more to thefirm than returns occurring in future

years even though those returns aregreater


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Internal "ate of "eturn #I""$


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Internal "ate of "eturn Allows the ris! associated with an investment project to

be assessed

$he * is the rate o interest 1or discount rate4that makes the net present !a#ue , to zero

4elps measure the worth of an investment

Allows the firm to assess whether an investment inthe machine, etc- would yield a better return basedon internal standards of return

Allows comparison of projects with different initial

outlays Eet the cash flows to different discount rates

Eoftware or simple graphing allows the I"" to befound


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Profitability Inde%


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Profitability Inde%

Allows a comparison of the costsand benefits of different projects

to be assessed and thus allowdecision ma!ing to be carried out

>et +resent a#ue

+roitabi#ity *nde) , --------------------- *nitia# Capita# Cost


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ey considerations or irms inconsidering use:

ase of use2degree of simplicity required

3egree of accuracy required

%tent to which future cash flows can bemeasured accurately

%tent to which future interest rate

movements can be factored in andpredicted

&ecessity of factoring in effects of inflation

Documents

Investment 1