12-10-2012, 01:53 PM
Investment Appraisal
investment1.ppt (Size: 313.5 KB / Downloads: 216)
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
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
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
Net Present Value
Takes into account the fact that money values change with time
How much would you need to invest today to earn x amount in x years time?
Value of money is affected by interest rates
NPV helps to take these factors into consideration
Shows you what your investment would have earned in an alternative investment regime
The principle:
How much would you have to invest now to earn £100 in one year’s time if the interest rate was 5%?
The amount invested would need to be: £95.24
Allows comparison of an investment by valuing cash payments on the project and cash receipts expected to be earned over the lifetime of the investment at the same point in time, i.e the present.
Discounted Cash Flow
An example:
A firm is deciding on investing in an energy efficiency system. Two possible systems are under investigation
One yields quicker results in terms of energy savings than the other but the second may be more efficient later
Which should the firm invest in?
Internal Rate of Return
Allows the risk associated with an investment project to be assessed
The IRR is the rate of interest (or discount rate) that makes the net present value = to zero
Helps measure the worth of an investment
Allows the firm to assess whether an investment in the machine, etc. would yield a better return based on internal standards of return
Allows comparison of projects with different initial outlays
Set the cash flows to different discount rates
Software or simple graphing allows the IRR to be found