Investment Appraisal Methods

Topics: Net present value, Rate of return, Internal rate of return Pages: 8 (2454 words) Published: May 2, 2012
What is meant by investment appraisal practices?
The investment appraisal process includes the generation of ideas, assessment and authorization, implementation and control of the project (Dennis R. Young, 2007). Decision-making is increasingly more complex today because of uncertainty. Additionally, most capital projects involve numerous variables and possible outcomes. For instance, estimating cash flows associated with a project involves working capital requirements, project risk, tax considerations, expected rates of inflation, and disposal values. It is necessary to understand existing markets to forecast project revenues, assess competitive impacts of the project, and determine the life cycle of the project. Investment Appraisal is therefore more than the identification and evaluation of suitable projects. It includes consideration of timing and the identification and balancing of risk. The importance of investment appraisal practices

A major problem for decision makers in enterprises is the appraisal of potential investment projects that can absorb capital assets. This evaluation, also known as investment appraisal, is really crucial for the future of any firm, since it determines the financial sources of the firm's budget and ultimately defines the level of the shareholders wealth. In theoretical finance, several methods of investment appraisal are developed in order to help financial managers or accountants to evaluate with increased certainty cash flows, viability and profitability of any investment project (Rosenberg, 2001). Capital budgeting decisions are among the most crucial and critical business decisions that any bank can take to achieve economic development (Dr P Shanmuka Rao, 2010). Given the importance of investment decisions, it is essential that there is proper screening of investment proposals. Vast sums of money can be easily wasted if the investment turns out to be wrong or uneconomic. The purpose of investment appraisal is to assess the economic prospects of a proposed investment project. In essence, an investment appraisal is the measure of capital value and its feasibility to the company. It is a methodology for calculating the expected return based on cash flow forecasts of many, often inter-related, project variables. All the same, no appraisal technique can guarantee success as risk emanates from the uncertainty encompassing these projected variables.

Specific investment decisions
A business organization has to quite often face the problem of capital investment decisions. The following are some of the cases where heavy capital investment may be necessary (Antonio, 2010): -Replacement: Replacements of fixed assets may become necessary either on account of their being worn out or becoming outdated on account of new technology. -Expansion: A firm may have to expand its production capacity on account of high demand for its products and inadequate production capacity. This will need additional capital investment. -Diversification: A business may like to reduce its risk by operating in several markets rather than in a single market. In such cases, capital investment may become necessary for purchase of new machinery and facilities to handle the new products. -Miscellaneous: A firm may have to invest money in projects which do not directly help in achieving profit oriented goals. For example, installation of pollution control equipment may be necessary on account of legal requirements. Thus, funds will be required for such purpose also. The firm may face basically with three types of major decisions: 1.Accept/Reject Decisions

2.Mutually exclusive Project Decisions
3.Capital Rationing Decision
Money (that is cash) has a different value over time; holders of money can either spend the money on consumption now or delay the consumption by investing the money until it is required for consumption. The reward for the...
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