Capital investment appraisal 2

Capital investment appraisal 2 tài liệu, giáo án, bài giảng , luận văn, luận án, đồ án, bài tập lớn về tất cả các lĩnh v...

Trang 1

Business Accounting 1

Chapter 20: Capital investment appraisal

 On completion of this topic you should be able to

 Explain the purpose of capital investment appraisal

 Calculate and interpret the payback period for an

Trang 2

Capital investment appraisal

 Whilst cost accounting provides information to management for making short-term decisions about revenue

expenditure, this topic provides information for long-term decisions about capital expenditure

 Capital investment appraisal is ‘the evaluation of proposed investment projects, with a view to determining which is

likely to give the highest financial return’ (Collis and Hussey, 2007, p 335)

Trang 3

Characteristics of capital investment decisions

Nature Strategic (eg whether to build or buy a

new factory)

Level of

External factors Very important (eg interest rates and

rates of inflation)

Typical techniques Payback period

Accounting rate of return Discounted cash flow techniques Adapted from Jones, 2002, p 452

Trang 4

The capital investment decision

 Capital investment appraisal techniques are used for making decisions concerning the investment of large amount of capital in a long-term project

 Management needs to know that the investment project will be worthwhile

 Either it will generate more cash than the initial amount

invested or it will provide cost savings over the life of the project that will exceed the capital invested

 At the very least, management needs to know that the business will get its money back

Trang 5

Exercise 1

Capital investment decisions

Trang 6

Exercise 1

Trang 7

Solution 1

Trang 8

Solution 1

Capital investment decisions (continued)

 Machine 3 looks best as the net cash inflow is £25,000 (£5,000 higher than for Machines 1 or 2)

 But waiting until Year 3 to get most of the cash increases risk – the annual net cash flows are estimates and the further ahead the forecast, the more unreliable it is

 Machines 1 & 2 both give the same total net cash inflow, so either is worth considering, but Machine 1 is the more

favourable because the cash comes in sooner

 It’s difficult to decide - we need a technique to help

Trang 10

Payback period

 The payback period is ‘the time required for the predicted net cash flows to equal the capital invested in a proposed

investment project’ (Collis and Hussey, 2007, p 338)

 The project that repays the capital invested in the

shortest time is considered to be the most favourable

 The following estimates are needed

 The amount of capital required

 The amount and timing of the net cash flows

generated by the investment project

Trang 11

Conventions and assumptions

 Year 0 is a conventional way of referring to the start of Year 1

 Year 1, 2, 3 etc means the end of Year 1, 2, 3, etc

 It is assumed that the cash outflow from the initial investment of capital will take place at Year 0

 It is assumed that the net cash inflows during a year will be received evenly throughout the year

 Negative cash flows are shown in brackets

Trang 12

Exercise 2

Mr Cornetto’s ice cream van project

Trang 13

Solution 2

Mr Cornetto’s ice cream van project

 The payback period for the ice cream van project is

Initial capital investment = £12,000 Annual net cash flow £4,000

= 3 years exactly

 We have been able to use this formula because Mr Cornetto expects the net cash flows to be the same every year over the life of the project, but we can’t use it if the projected annual net cash flows are expected to differ…

Trang 14

Exercise 3

Mr Cornetto’s pasta van project

 An alternative project is to invest in a pasta van that will also cost £12,000 and last 4 years

 Because take-away pasta may take some time to catch on, the annual net cash flows are expected to be £2,000 in year

1, rising to £3,000 in year 2, £5,000 in year 3 and £6,000 in year 4

 Required

 Using the pro forma, calculate the payback period in

years and months for the pasta van project

Trang 15

Pro forma

Trang 16

Solution 3

Trang 17

Advantages and disadvantages of payback period

 Simple to calculate and easy to understand

 Useful for risky projects where prediction of future cash

flows beyond first few years is difficult (eg IT)

 Useful if short-term cash flows are more important to

survival of the business than long-term cash flows

 Useful if borrowing or gearing is a concern

 Does not take account of the time value of money (cash

now is worth more than cash received later)

 Ignores cash flows after the payback period

Trang 18

Accounting rate of return

 The payback period focuses on cash flows, but the accounting rate of return (ARR) focuses on profit

 The accounting rate of return ‘measures the predicted average profit before interest and tax as a percentage of the

average capital employed in a proposed investment project’ (Collis and Hussey, 2007, p 342)

 When comparing ratios from different sources, care must be taken that the same definition of profit and capital

employed have been used

Trang 19

Exercise 4

Fresh Farm Foods ARR

Trang 20

Pro forma

Trang 21

Solution 4

Trang 22

Conclusions

Advantages and disadvantages of ARR

 Advantages

 Simple to calculate and easy to understand

 Takes account of the entire life of the project

 Compatible with the performance ratio, ROCE

 Disadvantages

 Does not take account of the time value of money

 Ignores the timing of profits (eg benefit of earning a larger

proportion of profit in early years) and timing of cash flows

 No standard definition of terms (limits comparisons)

 Averages can be misleading (actual figure may be ↑ or ↓)

 No guidance on what is an acceptable rate of return

Định dạng
Số trang	22
Dung lượng	365,5 KB