Investment Appraisal Techniques
Investment Appraisal
Investment: Spending money into something with an expectation of making profit/ increasing wealth in the future
Investment Appraisal: Is a process of evaluating the attractiveness of an investment proposal using various techniques/methods, Methods
Payback period Accounting rate of return (ARR – ROCE) Investment appraisal Internal rate of return (IRR)
Pay Back Period (PBP)
The Payback Period (PBP) - The time taken by the project to repay the investment or
The time taken where, Cash inflows = Cash Outflows * Usually expressed in years
It really considers the flow of cash into the business and outside the business
Decision Rule: A project is good if PBP is either equal or lower than the target period But PBP is not adequate on its own as an investment appraisal technique.
Example
Project P Project Q $ $
Capital investment 60,000 60,000
Profits before depreciation (a rough approximation of cash flows)
Year 1 20,000 50,000
Year2 30,000 20,000
Year3 40,000 5,000
Year4 50,000 5,000
Year5 60,000 5,000
Here,
PBP for P More than 2 year
PBP for Q Less than 2 year
So, on the basis of PBP project Q is preferred
However, if we look at the total returns of the project over the period of 5 years, Project P appears to be better as total return is $200,000 where as total return under project Q is $85,000.
Conclusion: PBP on its own is not an adequate investment appraisal technique.
Advantages:
* simple and easy to calculate and understand * Uses cash flows rather than accounting profits * It can be used as screening device as a first stage in eliminating obviously inappropriate projects prior to more detailed evaluation
Disadvantages:
* It ignores timing of cash flows within the PBP * It does not take into account of time value of
Investment: Spending money into something with an expectation of making profit/ increasing wealth in the future
Investment Appraisal: Is a process of evaluating the attractiveness of an investment proposal using various techniques/methods, Methods
Payback period Accounting rate of return (ARR – ROCE) Investment appraisal Internal rate of return (IRR)
Pay Back Period (PBP)
The Payback Period (PBP) - The time taken by the project to repay the investment or
The time taken where, Cash inflows = Cash Outflows * Usually expressed in years
It really considers the flow of cash into the business and outside the business
Decision Rule: A project is good if PBP is either equal or lower than the target period But PBP is not adequate on its own as an investment appraisal technique.
Example
Project P Project Q $ $
Capital investment 60,000 60,000
Profits before depreciation (a rough approximation of cash flows)
Year 1 20,000 50,000
Year2 30,000 20,000
Year3 40,000 5,000
Year4 50,000 5,000
Year5 60,000 5,000
Here,
PBP for P More than 2 year
PBP for Q Less than 2 year
So, on the basis of PBP project Q is preferred
However, if we look at the total returns of the project over the period of 5 years, Project P appears to be better as total return is $200,000 where as total return under project Q is $85,000.
Conclusion: PBP on its own is not an adequate investment appraisal technique.
Advantages:
* simple and easy to calculate and understand * Uses cash flows rather than accounting profits * It can be used as screening device as a first stage in eliminating obviously inappropriate projects prior to more detailed evaluation
Disadvantages:
* It ignores timing of cash flows within the PBP * It does not take into account of time value of