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A2 5. FINANCE & ACCOUNTINGChapter 36 Investment Appraisal
See case study page 518 Glasgow NHS & Nigerian water
Intro page 518
Investment:
• Purchase of capital goods & improving fixed assets in order to
generate increased returns, and specifically, returns from the
investment under consideration during its expected lifespan.
• It involves risk in terms of cash outflow from the business.
Investment appraisal:
Evaluating the profitability or desirability of an investment project or
option.
Methods include:
• Quantitative appraisal techniques:
1. Payback Period.
2. Average Rate of Return.
3. Discounted Payback.
4. Net present Value.
5. Internal Rate of Return.
• Qualitative appraisal.
• Gutfeel (of entrepreneurs or experienced senior managers or
directors).
, Quantitative Investment Appraisal
Information needed:
1. Initial cost (including installation costs of machinery).
2. Estimated lifespan (over which returns can be generated from
the investment).
3. Residual value of the asset.
4. Expected returns from the investment less annual running
cost of the investment Net return or net cash flow from the
investment.
N.B. Most of the above are estimated thus results cannot be said
to be definitive.
Annual forecasted net cash flow = forecasted cash inflows
(revenue from the investment) less forecasted cash outflows
(annual operating costs).
N.B. Forecasting future revenue and costs of the investment
accurately is likely to be very difficult, particularly if the expected
lifespan is very long.
A number of external (PESTLE) factors may impact on actual
results. See example page 520
Managers must bear this in mind at all times when making
investment decisions.
The bottom line is whether profits generated are likely to outweigh
these risks. Activity 36.1 page 520
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