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NotesVilla Academic Team Notes

Investment Appraisal in Business

Author: Vibha Singh
Institution: University of Lucknow
Purpose: The purpose of these notes is to help educators
and post-graduate students understand the meaning of
investment appraisal in business
...
We also discuss
cash flow analysis and its various components
...

Audience: Educators or post-graduate students
Keywords: business, investment, project, cost, analysis,
flow, value, financial, capital, appraisal, rate, return
...


Investment Appraisal - Economic and financial feasibility of projects are the

key topics of investment analysis
...
Project analysts can then evaluate if the potential return on investment

compares favorably to alternative investments in other projects (the opportunity cost
of the investment)
...
Because private sector businesses are primarily focused on
the profitability of their assets, investment appraisal is also known as financial
analysis or capital budget
...

● Similar investment appraisal methodologies are utilized in public sector
initiatives as well as projects involving public-private partnerships
...

● However, rather than focusing solely on economic effects, investment
appraisal in the public sector typically takes into account broader factors, such
as the impact on employment, poverty, and external costs and benefits
(externalities)
...


(Image source: https://www
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com/investment-appraisal-2/)
2
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To assess the
liquidity and solvency of the company, organizations should monitor and analyze
three different types of cash flow: cash flow from operating operations, cash flow
from investing activities, and cash flow from financing activities
...
Businesses correlate line
items in the three cash flow categories to do a cash flow analysis to see where
money is flowing in and going out
...

● They can infer information about the state of the industry from this
...

● Bringing in money is not always a good thing, depending on the type of
financial flow
...

● Spending cash is not always a negative thing
...
Capital Expenditure - This comprises the financial outflows related to the cost
of purchasing assets like structures, machinery, plant, and equipment, as well
as design and training expenses
...
Such investments are referred to as fixed assets in
financial accounting terminology and are depreciated to account for their loss
in value and to allow for capital replacement
...
Investments may
have a written-down or residual value after a project's operational life that will
reflect their scrap or disposal value
...

● Due to decommissioning charges, reclamation costs, etc
...

● Companies make this kind of financial investment to broaden the scope
of their operations or to add some potential economic gain
...

● It can provide information on how much a company invests in new and
current fixed assets to support or expand its operations
...


(Image source: https://www
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com/terms/c/capitalexpenditure
...
Annual Operating Costs - These are the expenses incurred to run the project,
including labor costs, raw material or other stock costs, water and electricity
prices, etc
...

It refers to the expenses spent to keep your firm running daily
...
These costs include rent,
wages, and other overhead expenditures, as well as costs for raw materials
and upkeep
...
It does not include non-operating costs associated with
finance, such as interest, investments, or currency exchange
...

● It appears on a company's income statement after operating income,
which is calculated by subtracting it from sales
...


● Companies must keep track of both running expenditures and
expenses related to non-operating activities, such as interest payments
on loans
...
are a few
examples of non-operating expenses
...

● You must therefore subtract operating costs from your entire business
revenue
...
Annual Revenue - These will result from the selling of the project's output,
bringing positive cash flow into the business
...
As an alternative, some
investment strategies boost productivity, which reduces annual operating
expenses; these cost savings can be viewed as positive financial benefits for
the company
...
For each year of the anticipated
project life, these yearly revenues less yearly operating expenses will equal
the project's annual net cash flows (NCFs)
...

● Finding this number makes it possible to compare your company's
performance to that of past years as well as to that of competitors, and
it also allows you to determine how much revenue your business is
bringing in
...

● Because it gives them useful business information, it is an essential
measure that businesses monitor
...

3
...
Techniques used in the
private sector for appraisal are heavily focused on financial analysis and commercial
viability
...

The profit and loss account, balance sheet, working capital, source and application
of funds, and working capital statements are the fundamental elements of financial
analysis
...

● Organizations can improve employee performance within the company by
using the appropriate performance appraisal methodology
...

● Effective and gratifying employee performance reviews can be achieved with
the right methodology
...

● The various private sector appraisal methods involve Management by
Objectives, 360-degree feedback, assessment center methods, and more
...


3
...


Payback Method - Investors, financial experts, and businesses frequently

utilize the payback period as a way to estimate investment returns
...
It aids in calculating how long it takes for an investment's initial costs to be
recouped
...
Before making any judgments,
this statistic is helpful, especially when a quick assessment of a potential investment
initiative is required
...
The following formula
can be used to calculate the payback period:

Payback Period=Cost of Investment ÷ Average Annual Cash Flow
● Companies that employ the payback technique frequently approve or reject
projects based on a minimum acceptable payback period that has been
predetermined
...

● The length of time necessary to "pay back" or repay the initial investment is
assessed
...

● The time it takes to generate enough cash receipts from an investment to
cover the cash expenses for the investment is known as the payback period,
which is commonly expressed in years
...

● This may be done with the help of the payback period
...
2
...
It is the second most important
method for evaluating investments
...
Its calculation varies just a little bit
...
The fundamental form is the
percentage ratio of the accounting profit produced by an investment project to the
necessary capital expenditure
...

● To calculate the ratio or return that may be anticipated during an asset or
project, the average annual revenue of the asset is divided by the company's
initial investment
...

● It does not take into account cash flows or the time value of money, which can
be crucial components of keeping a business operating
...

3
...


Discounted Cash Flow Method - The term "discounted cash flow" (DCF)

refers to a method of valuation that calculates an investment's value based on its
anticipated future cash flows
...
Using estimates of how much money an investment will
make in the future, DCF analysis seeks to evaluate the value of an investment today
...
It can aid those who are trying
to decide whether to purchase securities or a firm
...

● Business owners and managers can use discounted cash flow analysis to
help them make decisions about operational and capital budgets
...

● The goal of a DCF analysis is to calculate an estimate of the return on
investment, taking time value into account
...

● A dollar you have today is worth more than a dollar you receive tomorrow
because it can be invested, according to the time value of money theory
...

● There are different types of Discounted Cash Flow Methods such as Net
Present Value, Internal Rate of Return, Benefit Cost Ratio, and more
...
Net Present Value - The sum of the discounted net cash flows over the
project's lifetime is the net present value (NPV) of the project
...
It is the present-day worth of all projected future cash flows
throughout an investment
...
The profitability of a proposed investment or project is
examined in capital budgeting and investment planning
...

b
...
The profitability of possible investments is calculated using this
indicator in financial analysis
...
To increase shareholder wealth, the decision
rule is to approve initiatives whose IRR exceeds the organization's cost of
capital and to reject any projects that do not match this condition
...


c
...
The ratio serves as a summary of
the overall relationship between the relative costs and benefits of a proposed
project in a cost-benefit analysis
...
Additionally known as the profitability index
...
The BCR contrasts the present values of all
costs and benefits associated with a project or asset
...


Bibliography:
What are investment appraisal and project funding? | APM
...
d
...
apm
...
uk/resources/what-is-project-management/what-is-investment-a
ppraisal-and-project-funding/
NetSuite
...
(2022, July 7)
...
Oracle NetSuite
...
netsuite
...
shtml
Payback Period Explained, With the Formula and How to Calculate It
...
Investopedia
...
investopedia
...
asp
Corporate Finance Institute
...
ARR - Accounting Rate of
Return
...
com/resources/accounting/arr-accounting-rate-of-ret
urn/

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