1. Prepared by Hanady Ali Osman
Block 4 Section 3 (Part I) The impact of innovation on business functions
Prepared by
Hanady Ali Osman

2. Innovation in Accounting & Finance Capital investment model (Page 34 binder)
Organisational environment
Strategic
Planning
Formal CI systems
Implementation
Analysis and
Acceptance
Monitoring and
Post-audit
Identification of
potential
investments
Project definition
And screening
Feedback
Organisational
personnel 2

3. Investment appraisal in organizational life (Pg. 39/40 Binder)
Lumijarvi (1991) investigated the methods used by
project champions to convince fund-holders
within organizations. He classified their
judgments into four main types of arguments:
Economic arguments
Strategic arguments
Non-economic arguments
Production technology arguments 3

4. Companies should accept innovations where: (Page 34 binder)
Benefits > Costs
Revenues
Reduction in costs
Economic and social benefits to donor-or-tax-funded public service users
Expenditure of the innovating organisation
Environmental & social costs. 4

5. CIA Techniques (Page 267 text)
Models for profit-making firms:
The payback period (PP) method.
Accounting rate of return (ARR)
The net present value (NPV) method
The internal rate of return (IRR) method 5

6. CIA Techniques (Page 43 Binder)
Models for non- profit or tax-funded
firms:
Cost-benefit analysis
Cost-effectiveness analysis 6

7. Why do investment decisions tend to be more important to investors?7

8. Importance of Investment decisions to investors
Large amounts of resources are often involved; if mistakes are made with the decision, the effects on the business could be significant
It is often difficult and/or expensive to ‘bail-out’ of an investment once it has been undertaken 8

9. Accounting Rate of Return (ARR) Method (Page 269 text)
The ARR method takes the average
accounting profit that the
investment will generate and
expresses it as a percentage of the
average investment in the project as
measured in accounting terms. 9

10. Accounting Rate of Return (ARR) Method (Page 269 text)
Average annual profit
X 100%
Average investment to earn that profit 10

11. Accounting Rate of Return (ARR) Method
e.g. a three-year project with a projected net
income of $100 in year1, $2000 in year2, and
$4000 in year3. The cost is $9000 which will
be depreciated by straight line method over
the project life. The salvage value equals to
zero. What is the ARR.? 11

12. Accounting Rate of Return (ARR) Method
Note that average investment = (cost + salvage value)/2.
Decision-rule: if ARR >ROE , then we accept the project. 12

13. Advantages of ARR method (Page 269-72 text)
A measure of profitability that many believe is the correct way to evaluate business.
Produces % figure of return that manager feel comfortable with
Easy to compare % returns on different investments to help make a decision
Links in with ROE as a method of measuring business performance 13

14. Disadvantages of ARR method (Page 269-72 text)
Focuses on accounting profitability rather than cash flows
Ignores time value of money (opportunity cost)
Create problems when considering different investments’ size 14

15. Payback period method (Page 273 text)
The PP method is the length of
time it takes for the initial
investment to be repaid out of
the net cash inflows from the
project. 15

16. Payback period method (Page 273 text)
Net cash Cumulative
flow cash flows
Immediately (Cost of machine) (100) (100)
1 years’ time (NP before dep.) (80)
2 years’ time (NP before dep.) (40)
3 years’ time (NP before dep.)
4 years’ time (NP before dep.)
5 years’ time (NP before dep.)
5 years’ time (Disposable proceeds)
Payback period = 2 2/3 years 16

17. Advantages of PP method (Page 274-5 text)
Quick and easy to calculate
Easily understood
Focuses upon the short run, thus avoids the problems of forecasting far into the future.
An improvement on ARR in respect of the timing of the cash flows.
It emphasizes the importance of liquidity 17

18. Disadvantages of PP method (Page 274-5 text)
Not a measure of profitability
PP ignores the timing of the cash flows
Ignores cash flows beyond the payback period
PP cannot distinguish between projects having the same payback period
Not a suitable measure to deal with risk 18

19. Example of PP for 3 projects (Page 274 text)
Time
Cash flow
Project 1
Project 2
Project 3
Immediately (time 0)
(200)
1 year’s time 40 10 80
2 year’s time 20
100
3 year’s time
170
4 year’s time 60
200
5 year’s time
500 19

20. Factors influencing the discount rate to be applied to a project (Page 276-8 text)
Interest foregone
Inflation
Discount rate
Risk premium 20

21. Discounted cash flows techniques (Page 275 text)
These are appraisal methods that
take account of all the costs and
benefits of each investing
opportunity which, also makes a
logical allowance for the timing of
those costs and benefits. 21

22. Net Present Value method (Page 281 text)
This method calculates the present value of all the money coming in from the project in future and then sets it against all the money being spent on the project today.
Projects are only worth carrying out if the NPV is positive-otherwise just put your money in the bank and earn some interest. 22

23. Net Present Value method (Page 281 text)
Time
Cash flow
Calculation of PV PV
Immediately (time 0)
(100)
(100)/(1+0.2)0
1 year’s time 20
20/(1+0.2)1
16.67
2 year’s time 40
40/(1+0.2)2
27.78
3 year’s time 60
60/(1+0.2)3
34.72
4 year’s time
60/(1+0.2)4
28.94
5 year’s time
20/(1+0.2)5
8.04
24.19 23

24. Net Present Value method (Page 281 text)
The decision taken by the NPV is:
If NPV is positive the project is accepted
If NPV is negative the project is rejected 24

25. Using discount tables (Page 281 text)
Discount tables are easier ways to
calculate the present value of various
discount rates (r) over different periods
of time (n), instead of calculating each
through: /(1+ r)ⁿ 25

26. Advantages of NPV (Pg. 283 text)
Considers timing of the cash flow
Takes the opportunity cost of money into account
A single measure takes the amount and timing of cash flows into account
Can consider different scenarios i.e. what if?
Takes account of business objectives- assumed to be profit maximising. Positive NPVs enhance wealth whilst negative reduces wealth. 26

27. Disadvantages of NPV Complex to calculate and communicate
The meaning of the result is often misunderstood
Only comparable between projects if the initial investment is the same 27

28. Internal Rate of Return (IRR) method (Page 284 text)
The IRR is the discount rate that, when
applied to the future cash flows of a project,
will produce an NPV of precisely zero. It
involves trial and error at different discount
rates.
When the NPV equals zero the rate of
interest can be compared with pre-set criterion
internal to the firm, or with the prevailing rate
of interest. 28

29. The relationship between NPV & IRR method (Page 285 text)70 60 50 40 30 20 10
NPV
($000)
IRR
Rate of return (%) 29

30. Advantages of IRR
Projects with different initial values can be compared. The one with the highest IRR would be selected
All cash flows are taken into account
Timing of cash flows taken into account. 30

31. Disadvantages of IRR
It does not address the issue of wealth generation – it does not differentiate between the scale of the investment I competing projects. 31

32. Investment appraisal offers the following analysis
Decision making against a background on uncertainty
Balance risks against potential rewards
Questioning reliability of data 32

33. Helpful Exercises Activities 10.1 to 10.17 of Chapter
10 of Atrill & McLaney, Accounting & Finance for non specialist, 2001. 33

34. Donor-Funded and Tax-Funded Organizations (Pg. 43 Binder)
Innovation and economic appraisal and
analysis of innovative developments is
important in profit-making business as
well as in non-profit-making business.
Cost benefit analysis
Cost effective analysis 34

35. Cost benefit analysis (Pg. 43 binder)
This analysis is based on the principle
that a project should achieve the greatest
potential gain from a given cost, and
should not be undertaken unless their
benefits exceed its costs. Here cost and
benefits expressed on financial terms
(money). 35

36. Cost effective analysis (Pg. 43 binder)
This analysis the costs of alternative
ways of achieving a similar outcome are
compared, the one with the lower costs
being considered more cost effective.
Here cost and benefits need not
expressed on financial terms (money). 36

37. Donor-Funded and Tax-Funded Organizations (Pg. 44 Binder)
Risk analysis in non-profit projects is important as in profit-projects. Government organizations have come to two types of risk:
Fiscal risk: not opening up a government’s treasure chest through providing projects with open-ended funding.
Political risk: taking account of how projects will be seen by political backbenchers, the press and media, and by voters.
Note that cost effective analysis has uses in the profit-making firms, in which the intended outcome of the innovation is decided upon, and the issue is to compare the cost of alternative ways of achieving this outcome. 37