Notes on Section E (1 to 4)

Investment appraisal requires two main things: CAPITAL COST and the VALUE of the PROJECT. Investment Appraisal is considered a forward-looking process. It considers what my happen and calculates finance returns. The basis of investment appraisal is based on the estimates of the future cash flow. Cash Outflow is referring to all of the costs of the project; it uses a series of sub estimates that are aggregated to get the overall cost. Cash Inflow refers to the estimated vale of the project; it is expressed in terms of net-cash inflow. Net Cash Inflow is the additional cash that a project will generate. The main estimate of the net cash inflow is base on a sales forecast that the marketing department will produce. The net cash flow is a cash flow forecast not a profit forecast. Most of the cash inflows tend to be overestimated, most of the marketing department will tend to be optimistic and this is the reason why the forecast will tend to be overestimated. Some of the reasons for firms inaccuracy are the following: firms are not vacuums, firms cannot always predict the prices of the products and the cost of labor since the costs may vary with time, some items are difficult to predict. Estimate of What The Project Will Cost is referring to the capital investment that the business has to invest on the project. Estimate of What the Project Will Earn is referring to the forecast of the net cash inflow. Both capital investment and the net cash inflow are considered to be estimates and not 100% accurate.

Investment Appraisal Techniques

They are simple and easy to calculate. Good for screening out projects form a long list. All projects should be subject to these tests. The tests are: 1) Payback Period and 2) Average Rate of Return (ARR) If the project passes the initial screening tests then it is subject to the next more complex tests. The tests are: 1) Discounted Cash Flow and 2) Net Present Value

The Payback Period refers to a method in investment appraisal, which the time period of recovery for a business to recover the initial cash outlay or investment.

Benefits of payback method

Easy to calculate and understand Includes the cost of the investment Focuses on short-term cash flow and is appropriate for equipment with a relatively short life.

Limitations of payback period

Not a measure of profit. Ignores all cash flows after the payback point. Ignores the pattern of cash flow. Ignores the 'time value' of money. Encourages a short-term view of investment.