1. Introduction to Investment & Project Appraisal

EDABS 202 - CFM - Topic 02 -Investment Decisions & Project Appraisal

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Conducted by Nadun Kumara 1

TOPIC 02INVESTMENT DECISIONS & PROJECT APPRAISAL

EDABS 202 – Corporate Financial Management (CFM)

Conducted by Nadun KumaraMBA(USJP), ACMA(UK), CGMA(USA), BA(Hons)(UK), DipPsychOrg(UK)

1. Introduction to Investment & Project Appraisal


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Investment & Project AppraisalIntroduction

What is an INVESTMENT??

An investment is the expenditure of a significantamount of money, on the purchase of a tangible asset.

What is a PROJECT??

A project is the expenditure of a significant amount ofmoney, on a temporary effort with a definedbeginning and end, undertaken to meet unique goalsand objectives.

Investment & Project AppraisalIntroduction

What is APPRAISAL??

The act of estimating or judging the nature orvalue of something or someone.

an INVESTMENTor

a PROJECT

Let us refer both these as “INVESTMENT” for ease of reference from

now on….


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Investment & Project AppraisalIntroduction – Practical Example

US $ 243.8

MILLION US $ 389.89

MILLION

BOEING 787 AIRBUS A380

Investment & Project AppraisalIntroduction – Practical Example

Write two examples of “Investments” made by your company…

Name of Company: ………………………..

Exa 01

Exa 02


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2. Steps of Appraisal

Investment & Project AppraisalSteps of Appraisal

1. Initial Investigation1. Feasibility (Technical & Commercial)2. Risk3. In line with organisational goals & objectives?

2. Detailed evaluation1. Return from the project

(our topic – Investment Decisions & Project Appraisal)2. Detailed risk analysis (i.e. ‘What if?’ method)3. Finance needed


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Investment & Project AppraisalSteps of Appraisal

3. Authorisation

4. Implementation

5. Monitoring

6. PCA

Investment & Project Appraisal

Investment & Project Appraisal

NON-FINANCIAL appraisal

FINANCIAL appraisal

Pg. 234 – 1.2 1. Accounting Rate of Return (ARR)2. Payback Period / Method3. Discounted Payback Period / Method4. Net Present Value (NPV)5. Internal Rate of Return (IRR)


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3. Non-financial Appraisal

Investment & Project AppraisalNon-financial Appraisal

• Political factors

• Legal factors

• Ethical factors

• Quality implications

• Personnel issues


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4. Financial Appraisal (ARR/PB/DPB/NPV/IRR)

Investment & Project AppraisalFinancial Appraisal

1. Accounting Rate of Return (ARR)

2. Payback Period / Method

3. Discounted Payback Period / Method

4. Net Present Value (NPV)

5. Internal Rate of Return (IRR)

Discountedcash flow

Techniques(DCF techniques)


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• Let us learn the area using a calculation.

• But first, the terminology…


• Cost / Investment

• Useful Life


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• Residual Value / Scrap Value

• Depreciation


• Return to the company – Cash Flow


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• Return to the company – Profit


• Cost of Capital / Discounting Factor (DCF) / Required Rate of Return


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Ground Work – 3 STEPS



Step 1

CF PROFIT

PROFIT CF

Step 2

Calculate Depreciation

Depreciation = Cost – Residual Value

Useful Life

- Dep

+ Dep


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Step 3Year CF - Dep Profit

1

2

3

Year Profit + Dep CF

1

2

3


1. Accounting Rate of ReturnThe rate (%) of return (profit) the company makes through the investment with comparison to the investment.


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1. Accounting Rate of Return

Average Profit X 100Average Investment


Basis for recommendation…. 3 scenarios

Scenario 01“No Benchmark”

Scenario 02“Benchmark

Provided”

Scenario 03“Two or More

Options to Compare”


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1. Accounting Rate of Return

I recommend/do not recommend company name toinvest in this asset name, because the ARR isanswer.


2. Payback Period / MethodThe length of time taken for the total cash outlfow (investment) to be recovered by the total cash inflows.

Total Cash Outflow = Total Cash Inflow


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When next year’s Cash Inflow is more than therequired Cash Inflow, for the total cash inflow tobecome equal to total cash outflow (payback periodpoint)….

Required CF X 12Next Year’s CF





Provided”




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I recommend/do not recommend company name toinvest in this asset name, because the PaybackPeriod is answer.


1. Accounting Rate of Return (ARR)





Discountedcash flow

Techniques(DCF techniques)


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• Discounted Cash Flow Techniques

• Why discount?• Because of TIME VALUE OF MONEY


• Discounted Cash Flow Techniques

• TIME VALUE OF MONEY• This is a fundamental idea in finance that money that one has

now is worth more than money one will receive in the future. • This is due to factors such as;

• Inflation• Interest forgone• Risk• Human Preference


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3. Discounted Payback Period / MethodThe length of time taken for the total cash outlfow (investment) to be recovered by the total cash inflows.But now, we take the ‘TIME VALUE OF MONEY’ concept also into consideration.

Total Cash Outflow = Total Cash Inflow





Provided”




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I recommend/do not recommend company name toinvest in this asset name, because the PaybackPeriod is answer.


4. Net Present Value (NPV)The difference between the present value of the future cash flows from an investment and the amount of investment. Present value of the expected cash flows is computed by discounting them at the required rate of return.


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Provided”





I recommend/do not recommend company name toinvest in this asset name, because the NPV is apositive/negative answer.


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5. Internal Rate of Return (IRR)The rate (%) of cash return that the company gets by investing in the project.



IRR = Lower DCF + (+ NPV) X (Higher DCF – Lower DCF)

[+ NPV - (- NPV)]


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5. Internal Rate of Return (IRR)As the discount rate increases, the PV of future cash flows is lower and the NPV is

reduced

Example: Hot Dog Cart Valuation

-30

-20

-10

0

10

20

30

40

50

0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 22% 24%

Discount Rate (%)

NPV

($)

IRR: Discount rate at which the project has a NPV of zero

Internal rate of return (IRR) is the discount rate that sets the NPV to zero





Provided”




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I recommend/do not recommend company name toinvest in this asset name, because the IRR ishigher/lower than the company’s cost of capital(COC).

THANK YOU..!

1. Introduction to Investment & Project Appraisal

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