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Investment Appraisal Techniques - Essay Example

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Investment Appraisal Techniques

Some of the investment appraisal techniques used range from Net Present Value (NPV), Accounting Rate of Return (ARR), Internal Rate of Return (ARR) and Payback Period. Net Present Value (NPV) As one of the investment appraisal techniques, net present value (NPV) method ensures that the value of all the expected future cash flows is calculated into the present values (Droms, & Wright, 2010). More significantly, the net present value (NPV) method takes into consideration the difference that arises between the present value of the expected cash inflows of a project and the present value of the expected cash outflows that the project will yield in the future (Crosson & Needles, 2011). This is essential in the determination of whether or not the project is viable in the present condition if the projected will yield the projected cash flow in the future (Moyer, McGuigan & Kretlow, 2008). Calculations are done using the discount rate of the cost of capital that is determined depending on considerations of the future projected risk of the project (Hastings, 2009). More so, the use of the net present value (NPV) method in capital budgeting is necessary because it analyzes the profitability level of the intended project (Mowen, Hansen & Heitger, 2012). Above all, use of net present value (NPV) method in capital budgeting analysis is critical because it is more sensitive as compared to other method because it relies on the future cash inflows that the project is expected to yield (Duenas, 2006). Net Present Value (NPV) method YEAR 0 1 2 3 4 TOTAL Initial Outlay (0) (300,000) (300,000) Sales revenue - - 350,000 390,000 410,000 1,150,000 Materials and components - (50,000) (65,000) (65,000) (50,000) (230,000) Salaries and Wages - (70,000) (80,000) (85,000) (85,000) (320,000) Depreciation - (45,000) (45,000) (45,000) (45,000) (180,000) Advertising - (25,000) (25,000) (25,000) (25,000) (100,000) Equipment disposal 120,000 120,000 Net cash flow (0) (490,000) 145,000 170,000 325,000 150,000 Discounted factor (15%) 1.0 0.8696 0.7561 0.6575 0.5718 Discounted cash flows (0) (426104) 109,634.50 111,775 185,835 (18,859.5) Overheads are not taken into account as expenses because it is not directly related with the project. More so, the overheads costs are related with the companies head office function. Accounting Rate of Return (ARR) Another investment appraisal technique that is used to estimate the expected rate of return of anticipated investment project is the accounting rate of return (ARR). More significantly, the use of the accounting rate of return (ARR) gives a more rapid way of estimating the expected net profits as a basis for comparing several different expected projects to be undertaken by a company (Siegel, Shim, & Hartman, 1998).  In addition, the accounting rate of return (ARR), takes an estimate of the returns that the expected project will yield during its entire useful life. As compared to the payback period method, the accounting rate of return (ARR) is rational as it considers the distribution of profits and not only the period the project is expected to take to get back the original amount of investment in the project (Brigham & Houston, 2009). One weakness of the accounting ...Show more

Summary

Investment Appraisal Techniques Name Here Name of Institution City, State Date Investment Appraisal Techniques In most instances, businesses are faced with a wide range of investment projects to invest in, as a way of generating income. More so, companies invest in projects to expand its business base by increasing its competition edge, production and reduce the cost it incurs (Shim & Siegel, 2001)…
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