1. Diploma in Management & Leadership Level 5 Week1 Lesson 1 Resource Management By Anjum Sattar Email a.sattar@bradrc.co.uk 15-Oct-15 Water Only 1

2. Aims and Objectives. Aim (s)  Introduction to investment appraisal  Types of investment appraisal Objective(s ) Learner will be able to….  Define investment appraisal  Differentiate between investment appraisal methods  Describe time/ value of money 15-Oct-15 2

3. Background Knowledge What do we know about investment appraisal 15-Oct-15 3

4. Investment appraisal  Investment appraisal is a business concept which compares expected future income to be derived from an investment with the expenditure of incurring the investment. In non-profit making organizations where investments are not made with the objective of earning a return, the concept may not always be directly applicable. In such organizations, investment appraisal techniques may be used to compare alternative proposals in order to provide the best value for the money spent Bodie Zvi and Merton Robert (1998).  Investment appraisal is used to look at a potential capital investment by a firm and measure it’s potential value to the firm. There is more than one method of Investment Appraisal, and each different method allows the potential return on the investment to be examined in a different way Atrill Peter (2006).. 15-Oct-15 4

5. Investment appraisal methods  Payback Period  Discounted payback  Net present value  Internal rate of return  Sensitivity analysis  Break-even analysis  Accounting rate of return 15-Oct-15 5

6. Time value of money What a difference between £1 now and £1 in a year’s time? Factors change the value of money Interest cost Inflation Other risks to materialise the money For example: the annual interest rate is 10%, I lend you £1 now and will get back after 1 year, how much worth of that £1 in a year’s time? ? x (1+10%) = £1 ? = £0.91 10% is called “cost of capital”; “?” is called the “discount factor” 15-Oct-15 6

7. Payback period The payback period is the amount of time taken for the net cash flow resulting from an investment to match (=), the initial cost of the investment (F9 Kaplan book ACCA. Formula Payback period = Initial investment/Annual cash flow This formula is only applicable if equal cash flows 15-Oct-15 7

8. Advantages /Disadvantages of Payback method Advantages  Simple to use.  Assists with cash flow  Effective when technology is fast  Changing Disadvantages of Payback method  Ignores flows of cash over the lifetime of  the project.  Ignores total profitability. 15-Oct-15 8

9. Payback Example - 1 15-Oct-15 9

10. Payback Example - 1 15-Oct-15 10

11. Payback period Look on cumulative cash flow in end of year 3 ( 400) left to meet initial investment and year four our cash flow is 500 so our payback period should be three years and some months. 400/500 =0.8 years so 0.8x12 = 10. Now payback 3 year and 10 months. 15-Oct-15 YearCash FlowCumulative Cash flow o(3100) 11000(2100) 2900(1200) 3800(400) 4500100 5500600 11

12. Discounted Cash Flow/NPV. DCS techniques are used in calculating the net present value of a series of cash flows. This measures the change in shareholder wealth now as a result of accepting a project. NPV = present value of cash inflows less present value of cash outflows.. If the NPV is positive, it means that the cash inflows from a project will yield a return in excess of the cost of capital, and so the project should be undertaken if the cost of capital is the organisation's target rate of return... If the NPV is negative, it means that the cash inflows from a project will yield a return below the cost of capital, and so the project should not be undertaken if the cost of capital is the organisation's target rate of return... If the NPV is exactly zero, the cash inflows from a project will yield a return which is exactly the same as the cost of capital, and so if the cost of capital is the organisation's target rate of return, the project will have a neutral impact on shareholder wealth and therefore would not be worth undertaking because of the inherent risks in any project. 15-Oct-15 12

13. NPV Pros(advantages) /Cons( disadvantages)  Pros Direct link to shareholder wealth, consider time value of money, uses all cash flows, absolute measure return.  Cons Difficult to explain, require a cost of capital, rather complex. 15-Oct-15 13

14. DF 10% Example of NPV 15-Oct-15 14

15. Net Present value 13-15 YearCash FlowDF8%PV 0(120000)1 1500000.92646300 2600000.85751420 3800000.79463520 4400000.73529400 NPV70640 15-Oct-15 15

16. Activity Calculate Payback period / Net Present value ( using cheat sheet) YearCash flow 0(1900) 1300 2500 3600 4800 5500 15-Oct-15 16

17. Payback/ Net Prevent value Application Payback and NPV method both useful to make any investment decision, either going to buy new machine, new building etc. All big organization using project appraisal to measure cost/benefits Helpful to measure which project is more valuable compare to other projects 15-Oct-15 17

18. Useful resource to enhance understanding in project appraisal  www.opentuition.com www.opentuition.com  www.accaglobal.com www.accaglobal.com  CMI Unit 5004 book  Youtube.com  Wikispaces.com / bradrc  www.cima.com www.cima.com  ACCA F9 book of Kaplan, BPP 15-Oct-15 18

19. Bibliography Bodie Zvi and Merton Robert (1998) Finance first edition pp62-65 Published by Prentice-Hall Inc New Jersey. Atrill Peter (2006) Financial Management for decision Makers 4 th edition pp60-68 Published by Pearson Education England ACCA F9 Kaplan press 15-Oct-15 19

20. 15-Oct-15 Assignment discussion Summary. Q & A 20

21. 15-Oct-15 Next Session. In Next Session we are going to Learn …… Internal rate of return Sensitive analysis Tuesday 07/08/2012 01:30 – 4:30 21