For an initial outlay of 300,000 GBP, for 5 years, with a constant cash flow of 35,000, we can compute IRR of the project to arrive at a rate which equates cash flows with the initial outlay and then finding out the net present value of the project to arrive at highest cost of capital…
Project appraisal techniques and methods vary in their importance and significance therefore their use is also dependent upon what are the intended objectives of the finance managers while assessing and evaluating projects. It is also important to note that the basic method which is now being widely accepted as more credible mean of project appraisals is based on the time value of money concepts. Since the project appraisal methods include both the TVM and non- TVM based methods therefore it is up to the finance managers to decide what basic philosophy and method they intend to apply.
Return on Investment is one of the several methods of making project appraisals. The basic philosophy behind this method is the fact that finance managers take the expected gains from the project with comparison to the total investment cost of the project. The basic formula for calculating Return on Investment is:
ROI is preferred method because of its simplicity. It is to calculate and can be handy and a quick mean of having a look at the overall value addition capability of the investment made. The basic criteria to judge the suitability of the project through this method is the fact that if ROI is positive than the proposed project may be undertaken.
It is also important to mention that ROI may not be the most sophisticated...
The basic criteria to judge the suitability of the project through this method is the fact that if ROI is positive than the proposed project may be undertaken.
It is also important to mention that ROI may not be the most sophisticated method as it has its own drawbacks. It is often argued that this figure can be easily manipulated because the accounting income figure can easily be tempered with by using different means of recording costs and profits. By changing the depreciation methods, the accounting income can easily be increased or decreased therefore ROI would also increase or decrease with the changes in accounting income.
Further, Return on Investment also do not take into account the time value of money.
Payback period is another non-TVM based method used for making decisions on project. Payback period is the time taken to recover back the initial investment made into any project. This method is technically considered as simple and easy to calculate. However, despite its use, this method has some serious flaws including following:
1) Cash flows after the payback period are not taken.
2) It does not take into account any element of risk.
3) Payback period cannot be considered as a method which can be used an indicator of wealth maximization for shareholders.
4) As discussed above, this method also does not take into account the time value of money.
Net Present Value
Net present value is one of the most widely used methods for making project appraisal methods as it is considered as more accurate methods. Net Present value is basically the difference between the present value of the cash outflows and Cash Inflows. If the present value of Cash Inflows is greater than Cash out flows, the project is accepted and if it is negative project is ...
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