Investment Appraisal

11 Key excerpts on "Investment Appraisal"

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  Accounting and Finance for Managers

  A Business Decision Making Approach

  • Matt Bamber, Simon Parry(Authors)
  • 2020(Publication Date)
  • Kogan Page

    (Publisher)

  The apparent sophistication and precision of financial Investment Appraisal techniques can mask shortcomings and behavioural aspects of their application. This chapter therefore includes evaluation of frequently used techniques within a wider behavioural context.

  Introduction

  Investment Appraisal is the process of deciding which projects or assets to invest in. In this chapter we will look at how to evaluate investments from a financial point of view and how such financial analysis fits into the overall investment decision process. Investment Appraisal should always be understood within the wider context of strategic formulation and implementation. Although such matters are beyond the scope of this textbook, this chapter will look at how non-financial factors, risk levels and wider strategic concerns can impinge upon the more traditional concerns of the immediate economic return from an investment.

  Investment Appraisal, sometimes referred to as capital Investment Appraisal, is concerned with organizational decisions about investment in equipment, machinery, buildings or other long-term assets. This can include a range of types of decision such as replacement of existing assets, investing in new IT or equipment to reduce operating costs, expansion through purchasing new buildings or equipment, improving delivery service or staff training. However, the principles apply equally to investments in shares in companies, whether made by businesses or individuals. Therefore the techniques looked at in this chapter are equally relevant to both businesses and individuals who are involved in making investments.

  The importance of good Investment Appraisal lies with the strategic and financial importance of the investments made. Investments will shape the future of the organization. Such investments often involve large resources. Wrong decisions can be costly and difficult to reverse and will have a direct impact on the organization’s ability to meet its strategic objectives.

  From a financial point of view, an investment involves making a cash outlay with the aim of receiving future cash flows in return. At a basic level, assessing the financial viability of an investment involves simply comparing costs with benefits, and ensuring that the benefits outweigh the costs. However, in practice this can prove difficult, as identifying and measuring the costs and benefits from an investment can be a complex task. This chapter will address some of the problems of investment cost–benefit analysis and look at how techniques have developed in order to meet these problems.

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  Strategic Managerial Accounting

  Hospitality, Tourism & Events Applications

  • Tracy Jones, Helen Atkinson, Angela Lorenz, Peter Harris(Authors)
  • 2012(Publication Date)
  • Goodfellow Publishers

    (Publisher)

  14 Capital Investment Appraisal 14.1 Introduction and objectives Capital investment is a medium or long-term strategic decision that is often a mul-timillion pound investment and is difficult to change direction once started. Capital Investment Appraisal is sometimes referred to as capital budgeting, as it relates to the allocation of funding for capital expenditure. Due to these factors, making the wrong decision can be very costly so it is important that any organisation under-takes a thorough appraisal of their potential capital investment projects prior to committing to them. Whilst this chapter focuses on financial appraisal, some con-sideration is given to the wider appraisal of projects, including the match to organi-sational strategy and risk management. After studying this chapter you should be able to: „ Understand the importance of capital Investment Appraisal (CIA) „ Develop a working knowledge of financial CIA techniques „ Appreciate the ‘time value’ of money in the CIA context; and „ Be able to consider the strategic implications of CIA decisions. 14.2 The value of Investment Appraisal For a company to continue to grow it needs to continue to invest and develop, looking at exploiting new market opportunities, plus redevelopment and updat-ing of existing assets in order to meet customers’ constantly changing demands. Investment Appraisal is a way of financially assessing the value of potential invest-ments to ensure financial resources are utilised effectively by the organisation. There are a number of different triggers for investment: keeping up with com-petitors; replacing old assets; expansion or to utilise newly developed technology. There are a number of alternative techniques that can be utilised in practice. Pike 228 Strategic Managerial Accounting (1996) has undertaken many surveys of industry practice, including longitudinal studies stretching from the 1970s to the 1980s.

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  Business Economics

  • Rob Dransfield(Author)
  • 2013(Publication Date)
  • Taylor & Francis

    (Publisher)

  The first part of the chapter looks at a key financial planning decision: whether or not to invest and how to appraise an investment opportunity. Investment involves using scarce resources to create capital to enable future growth. An investment decision is thus important both from the perspective of the economy and for the business carrying out the investment. In evaluating investment opportunities it is important to use Investment Appraisal methods. The chapter therefore explores different ways of appraising investment: the payback method, discounted cash flows and accounting rate of return.

  Finally, the chapter outlines financial planning within the context of the various sources of finance that are available to a business. Some sources of finance expose a business to greater risks than others, and this can be particularly dangerous when an economy is in recession and funds flowing into a business may be reduced.

  17.2  What is investment?

  Investment is a particularly important aspect of economic growth. Economists identify investment as an expenditure on (or purchase of) items that increase productive capacity (e.g. the purchase of a machine or machine tool). In addition, social investment involves investment in the capacity to increase social welfare (e.g. by building a new school or hospital). Investment is particularly important as it typically creates jobs and new expenditure in an economy which acts to boost growth. Investment is carried out by both the public sector and the private sector of the economy. This chapter focuses on various economic techniques that can be used to appraise the effectiveness of investment projects.

  The development and growth of a business usually takes place in a series of separate steps or projects. These can range from the purchase of an additional delivery van to the complete takeover of another business. These projects are investments because they involve adding to or replacing some of the operating assets of the business.

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  Executive Finance and Strategy

  How to Understand and Use Financial Information to Set Strategic Goals

  • Ralph Tiffin(Author)
  • 2014(Publication Date)
  • Kogan Page

    (Publisher)

  11 Investment Appraisal Investment strategy

  A ppraisal is a word much used by finance people, especially when it comes to strategic decisions. We have strategic investment, which can mean investment in non-current assets, tangible and intangible, that add to the infrastructure of the business and enhance earning capacity by means of higher revenues or lower operating costs and more efficient operation. To City folk, investment and strategic investment are more likely to be thought of as investment in companies supporting growth through acquisition strategy. Investment can also mean investment in people.

  This chapter outlines the models and measures that can be used to assess or appraise whether investment should be made, the essential tools for project appraisal, company valuation etc: this is maybe the most important part of financial strategy, investing for the future. If you want a value- destroying strategy, avoid rigorous Investment Appraisal!

  There are two paths or strategies to follow when investing: internal investment (growing the business as it exists now) and organic growth. Successful companies are very rigorous with their Investment Appraisal processes, especially where the overall strategy is of continuity and sustainability – that is, one of level or managed growth rather than rampant growth through diversification or more likely acquisition.

  In some sectors and in the minds of most CEOs whose ‘vision’ is only as far as their exit, organic growth is too slow. Growth must come from acquisition – an acquisition strategy.

  Whether ‘visions’ are achievable or not is fundamental, but once an acquisition has been identified, proper due diligence should be focused on modelling whether the growth in positive net cash flows is really attainable.

  Links between investment and financial strategy

  Investment in assets, plant and equipment or entire companies can be considered as a strategy and, for some, also the sole objective, that is, to grow by acquisition. Presumably there is a clear objective, that being to make an adequate return on the investment – maybe not in the short term but hopefully the long-term objective is return and not simply growth for growth’s sake.

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  Benefit-Cost Analysis

  Financial and Economic Appraisal using Spreadsheets

  • Harry F. Campbell, Richard P. C. Brown(Authors)
  • 2003(Publication Date)
  • Cambridge University Press

    (Publisher)

  1 8 2 Investment Appraisal: Principles Introduction This Chapter provides a simple introduction to the principles of Investment Appraisal. It starts with an outline of the logic of the Investment Appraisal process from the viewpoint of an indi-vidual considering a very simple type of project. During the course of the discussion of this process such concepts as the discount rate, discount factor, present value, benefit/cost ratio, marginal productivity of capital and internal rate of return are developed. The discussion then shifts to the economy as a whole and the role of Investment Appraisal in allocating resources between investment and the production of goods for consumption. The simple algebra of various investment decision-rules applied in the latter part of the Chapter is then presented, followed by a numerical example. Following this, some special concepts, such as annuities, economic depreciation, inflation and risk, are discussed in the context of Investment Appraisal. In the following chapter (Chapter 3), the discussion shifts to applications of the various investment decision-rules. Some of the applications rely on the simple algebraic concepts already discussed in Chapter 2, while some are developed using the basic tool of the benefit-cost analyst – the spreadsheet. Some issues already raised in this Chapter, such as the time value of money and the calculation of present value and internal rate of return, are explored further, while new concepts, such as comparison of projects and capital rationing are intro-duced and discussed. Investment Appraisal from a Personal Viewpoint Economists start from the proposition that an individual’s economic welfare in a given time period is determined by the quantity of goods and services she consumes in that time period; consumption of goods and services is taken to be the ultimate goal of economic activity.

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  Managing Financial Resources

  • Michael Broadbent, John M. Cullen(Authors)
  • 2014(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  Investment Appraisal The aims of this chapter are to: • Explain why capital investment decisions need a series of special techniques. • Illustrate the process of capital investment within an organization. • Present four capital investment evaluation techniques - net present value (NPV), internal rate of return (IRR), payback (PB) and accounting rate of return (ARR). • Apply the four appraisal techniques to capital projects. • Consider which techniques are used in practice and why. • Explain how risk may be built into the appraisal techniques. • Develop the post audit of capital investment decisions as a control mechanism. • Introduce the idea of cost benefit analysis applicable to public sector and not-for-profit organizations. Introduction Capital investment within any organization is crucial for that organ-ization's well-being and long-term survival. Capital investments are those which have long-term effects on the organization by providing benefits over a number of years. In terms of a company's balance sheet, capital investment is made up from fixed assets, current assets and current liabilities. While financial accountants use this classification, it would be equally valid to consider the balance sheet as a collection of on-going projects which are generating returns in the form of profits and cash flows. In fact any balance sheet is a collection of assets and liabilities relating to past capital investment decisions, which do not stop at each year end, as financial accountants would have us believe, but continue over several accounting periods (Figure 8.1). The balance sheet at say 31/12/3 in Figure 8.1 represents the assets and liabilities that relate to projects A, B, C and D. A company like Ford (UK) does not consider itself an owner of assets but a producer of motor vehicles, so project A could represent a particular model of small car, project Β a mid-range car, project C a tractor range, project Ε the new range of small cars to replace project A. 8

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  Tax and Optimal Capital Budgeting Decisions

  • Suzanne Farrar(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  3 Capital Investment Appraisal Introduction Having demonstrated that corporate taxation creates interactions between the firm's activities and incremental capital investment, this chapter will evaluate a number of commonly used methods of project appraisal and risk analysis in terms of shareholder wealth maximisation where complex tax situations exist. The chapter will also consider the role of financial project appraisal in the context of the firm's overall strategy, and review the empirical evidence on firms' capital budgeting techniques. The strategic context of project appraisal Although financial appraisal is often presented as an adequate basis for deciding whether or not to undertake a capital investment, it is not a complete framework for analysis especially for major strategic decisions. Factors such as improvements in the firm's competitive position may be difficult to quantify in financial terms. The key steps in strategic planning may be defined as: a) selecting the proper strategic goals after scanning the firm's internal and external environment; b) considering the financial implications of such a strategy and how it will lead to increased profits, cash flows and shareholder wealth; c) setting realistic and achievable organisational goals and objectives; d) successful introduction and implementation of the strategic plan; e) evaluating and monitoring the strategic plan in the light of changes in the firm's environment. (Shaw, 1993) The capital budgeting decision is linked to step (b) of the strategic planning process and must be consistent with the overall corporate strategy of the firm. The strategic planning literature (for example, Johnson and Scholes, 41 1993) is concerned with techniques for identifying strategies that will provide the firm with a sustainable competitive advantage in a complex and highly uncertain business environment.

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  Accounting for Business Studies

  • Aneirin Owen(Author)
  • 2007(Publication Date)
  • Routledge

    (Publisher)

  Chapter     18   Investment Appraisal  

  This chapter explores a variety of decision-making techniques.

  Objectives

  • Time value of money;
  • Net present value (NPV);
  • Internal rate of return (IRR);
  • Payback period (PBP);
  • Accounting rate of return (ARR).

  Introducing business Decisions

  Importance of the Subject

  M anagers take many types of decisions, some concerning the day-to-day running of a department or business and others of strategic importance. Strategic decisions often involve large sums of capital invested in long-term projects. Examples include buying a competitor company, launching a new product, modernising production methods and manufacturing in a foreign location. Once capital is committed to these projects it is difficult to withdraw. For instance, if a manufacturing facility has been planned, built and equipped, the only way to release the funds is to find a buyer for the new facility. This can be difficult, particularly as the most interested parties are likely to be competitors. Good strategic decision making and the careful appraisal of long-term investments is key to business success.

  Time Horizons

  Most managerial tasks operate within a 12-month time horizon. Strategic decisions usually operate within a five to ten-year horizon, which reduces the importance of the distinction between cash and profit. Within one year there can be marked differences between cash flow and profit, because of depreciation, stock, debtors and creditors, etc. Over ten years these differences are insignificant. Consider a business start up situation in which all the equipment and materials are paid for in the first month. The net cash flow profile compared to profits might be as follows:

  Structure

  In every year, especially the first year, there is a marked difference between cash and profit; however, taking the three years in total there is no difference. Because investment opportunities have implications stretching over a number of years, cash provides the more convenient basis for Investment Appraisal decisions, rather than profit. This also helpfully avoids judgmental issues such as depreciation, stock valuation, etc.

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  Risk and Foreign Direct Investment

  • C. White, M. Fan(Authors)
  • 2006(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The Investment Process and Decision Making: the Strategic Perspective 91 Strategy and the individual investment project It is impossible to ignore the strategic context in which an investment decision is made. Strategy is concerned with identifying specific oppor- tunities and risks, and is expressed in the strategic evaluation and appraisal of different investment projects. In many cases the evaluation is cursory. Already before any specific appraisal a selection of projects has taken place, sometimes unconsciously. Certain projects are more interesting, meriting consideration within the specific strategic context of the relevant enterprise, or are championed by influential stakehold- ers. Investment projects are dismissed with little attention if they do not fit the general strategic orientation of the enterprise and may be neglected if they have no champion. This is inevitable given the limited ability of decision makers to process all the data available to them. At its inception an investment is simply an idea, identified in the course of strategic thinking and championed by a particular individual or stakeholder group, a process sometimes referred to as intrapreneur- ship. It becomes a set of evolving constituent elements taking shape as relevant decision makers interpret the environments in which the project is to operate. Just as a strategy is said to emerge, so its con- stituent parts, the various investment projects making up the enter- prise strategy, can also be said to emerge. No investment can be regarded as an off-the-shelf proposal, although for simplicity this is usually taken as the starting point for the process of Investment Appraisal. In the process of evolution of a project, those developing the project mould the proposal to suit the various environments of oppor- tunity and risk to which the enterprise is exposed. Projects build on existing resources, capabilities and competencies and often add to these new but related assets.

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  Economic Role of Transport Infrastructure

  Theory and Models

  • Claudio Ferrari, Anna Bottasso, Maurizio Conti, Alessio Tei(Authors)
  • 2018(Publication Date)
  • Elsevier

    (Publisher)

  Chapter 5

  Investment Appraisal

  Abstract

  This chapter introduces the readers to the Investment Appraisal techniques. In particular, this chapter focuses on the cost–benefit analysis as it is commonly accepted as the most suitable tool for Investment Appraisal. Nevertheless, other decision-making tools are presented as multicriteria and multiobjective analyses and input–output techniques as well, highlighting how they can improve the Investment Appraisal results. Along this chapter, ethical concerns are raised to make the readers familiar with the possible implications depending on the different choices.

  Keywords

  Cost–benefit analysis; Decision-making tools; Ethical concerns; Investment Appraisal techniques; Monetary and nonmonetary techniques; Public resources

  Contents

  1. 5.1 The Goal(s) to Be Achieved
  2. 5.2 The Cost–Benefit Analysis
     1. 5.2.1 Benefits Deriving From Infrastructure Investment
     2. 5.2.2 Infrastructure Costs
     3. 5.2.3 How to Compare Benefits and Costs
        1. 5.2.3.1 The Net Present Value
        2. 5.2.3.2 The Internal Rate of Return
        3. 5.2.3.3 Other Indicators
     4. 5.2.4 Sensitivity Analysis
     5. 5.2.5 Risk Analysis
     6. 5.2.6 The Wider Economic Benefits
  3. 5.3 Multicriteria Analysis
  4. 5.4 The Correct “Timing” of Investment Appraisal
  5. 5.5 Input–Output Analysis

  Investment Appraisal is really a hard matter, namely when it regards infrastructure. This is due to the fuzzy boundaries on this kind of exercise. In fact, the impacts of transport infrastructure are geographically, temporarily, and socially dispersed and diversified.

  Nevertheless, it is important to have a tool, even an imperfect one, that can inform decision-makers, especially when resources—and especially public resources—are scarce.

  This chapter is devoted to analyzing the monetary and nonmonetary techniques that economists have proposed to perform ex ante transport investments appraisal. We will deal in particular with the Cost–Benefit Analysis (hereinafter CBA), the MultiCriteria Analysis (hereinafter MCA), and the Input–Output Analysis (hereinafter IOA). None of these techniques is optimal in re ipsa

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  Property Investment

  • David Isaac, John O'Leary(Authors)
  • 2011(Publication Date)
  • Bloomsbury Visual Arts

    (Publisher)

  Given that by the end of this chapter there will have been discussion and examples of valuations over three chapters, it is appropri-ate at that point to consider the debate regarding the accuracy expected of the valuation process. The chapter begins however by looking at development appraisal as property development creates property investment assets. Rather than buy property investments ‘off the shelf’ in the property market, large property investors will sometimes undertake property developments in order to create investment-grade property from scratch. 7.2 Development, a specialized form of investment It was mentioned in Chapter 5 that large corporate property investors, which include pension funds and insurance companies, will sometimes play the role of developer so that they have complete control over the type of building that emerges and which will entirely meet their investment specification. Indeed some of these funds have established development departments whose role it is to seek out development opportunities and undertake development appraisals. Even where the fund takes a more passive role and provides funds to an estab-lished developer to produce an investment-grade building, the fund will still look at development viability to ensure that it is getting value for money and is not exposing itself to a venture that is too risky. This section will therefore look at development as a specialized form of investment and in doing so the residual valuation method will come into focus because it is the development appraisal method most commonly used in these situations. The basic principle underpinning a residual valuation is that it works backwards from establishing the finished value of a development and then deducts all of Specialized Aspects of Property Investment Appraisal 173 the costs (including a profit margin) needed to get to that position. If a scheme is viable a residual sum will be left which is the total amount that could be paid for the site.

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