3.2 Investment Appraisal

Accounting vs. Finance Accounting Record keeping Produce reports Tax reporting Historical Operations Forecasting Finance Decision making Apply accounting reports Separate financial tools Investments and Projects

Investment Purchase an asset Capital project Yield financial benefits

Investment Appraisal Financial costs and benefits of an investment Payback Period Accounting Rate of Return Discounted Cash Flows Net Present Value

Payback Period Similar to break-even How long it will take for an investment to repay its original cost Contribution is revenue less costs related to producing the product and occurs before fixed costs or overhead are taken out.

Question a.Reasons could include: the potential for CFC to return healthy profits; CFC may have been undervalued at the time of purchase; Abramovich could simply be a big fan of the club, i.e. personal interest.

Question 3.2.1

b. There is no guarantee that CFC would be come profitable; Abramovich had spent a lot of his own money on the club; CFC were suffering from ‘huge financial losses’ so Abramovich is taking a risk by investing in such a business; the club was not estimated to break-even until some 7 years after Abramovich took over.

c. It would inform Abramovich how long it would take (as an estimate) before his spending on the club would generate enough revenue to pay back the value of the investment; a shorter payback period would tend to reduce the risk of such an investment project. Ultimately, it acts as a decision-making tool for risk assessment.

Payback Period Advantages Quick Simple Aid with cash flow problems Break even before asset is replaced? Compare projects Identifies quick returns Less prone to error Disadvantages Short-termism Contribution not constant Focus on time rather than profit

Accounting Rate of Return Calculates average profit of an investment aka Average Rate of Return Expressed as a % Compare to interest rate or to other investments to see if project is worth the investment

Question 3.2.2

a)$130,000 b) AtlantaBoston payback1 year, 10 mo2 year, 2 mo Project Atlanta has the shorter payback period, i.e. it reaches break even quicker (but by only 4 months)

c) ARR7.7%12.8% Both projects outperform the interest rate so are worth pursuing, but Project Boston has a much better ARR yet the project costs the same.

d) This depends on whether the firm’s priority was a quick return on the investment (in which case Atlanta would be picked) or if profit were more of a priority. Although there is a better ARR for Boston, much of the money is received at a later stage in the project’s timeline, i.e. it would be worth less in today’s value. Both projects have an expected annual return that is greater than the base interest rate. Nevertheless, Boston yields a significantly higher return than Atlanta, making it relatively more attractive despite its slightly longer payback period.

Qualitative Investment Appraisal Quantitative can be demonstrated numerically Qualitative all non-numerical factors

Qualitative Factors P.O.R.S.C.H.E Predictions Objectives Risk Profile State of the Economy Corporate Image Human Relations Exogenous Shocks

Business Strategy Consider risk factors Don’t forget the time value of money Importance of reliable data Look beyond the numbers

Question 3.2.5

a)Some of the dangers/risks might include – Cultural differences – American and British businesses may not be aware of the norms and cultures in India. For example, the clothing range from M&S must be adjusted to suit local tastes and climate. – Much of India’s population still suffers from mass poverty; this will limit the amount of consumer spending in the economy. – Developing countries will lack the infrastructure and communications networks that Western multinationals are used to. – Legislation is likely to be another potential barrier. Apart form different legal systems overseas, laws tend to be rather more lax and this can create all sorts of organizational problems.

b)Some of the opportunities might include: – Deregulation in India will make conducting business easier. – The huge potential increase in sales, due to the large customer base in India, can lead to improved profits. – India’s impressive economic growth means that there is likely to be increased demand for foreign imports. – Businesses in the retail, tourism, and aviation industries are likely to boom; thereby creating opportunities for related business sectors. – The large English-speaking community and skilled labor force also may present opportunities for Western multinationals.