Investment Appraisal will help me to identify what will be best to you for the organisations financial performance, I will use three different projects to identify which will be best for each of the different investment appraisals, I have shown a table with the three different projects and what will happen over the course of 5 years. DCF/NPV refers to the value of money over a period of time, this becomes important because all the money generated which is received in the future, it money which has lost value. It is worth less.
The advantage of using the DCF/NPV method is because it is dependant on the cash flow, the returns from different investment options can be compared easily and the opportunity cost of investment is taken into account. The disadvantage however of using the method of DCF/NPV is that it can be very time consuming. You would have to wait for annual financial reviews to be published and this may take up to a year. Information can become inaccurate if information is input into the computer incorrectly. In addition, if a computer cannot be used and the method does not provide accurate means of comparison if the initial outlay on projects is significantly different
ARR overcomes any problems that may occur for the payback method. The ARR works with the comparison of the average annual profit with the capital cost. The advantage if ARR are that the method focuses on the profitability of investment projects rather than the payback period and it is easy to compare different investment projects, the higher the ARR. The disadvantage of ARR is that it does not take the timing of the cash flow into account, from which a business can suffer with a poor of irregular cash flow. All calculation needs to be correct and up to date, other wise all information about organisation progress will be misleading.
The formula that is used to work out the Account Rate of return is Average Annual Profit x 100 Capital Outlay The average annual profit is total value of all the years divided by the number of years. Capital outlay is the money you spend. It can also be initial cost of something like machinery. I will go through this formula for all of the projects, to find out the rate of return.
Payback period is the time it takes to repay the initial investment in a project. The payback method involves calculating the payback period. This is very important to a organisation and it could decide whether an organisation is successful. The cost of items such as machinery and costly investments are very important because the more money the organisation makes the more quickly they can pay of the cost of the machinery.
Therefore, they will be able to make more profit more quickly, whereas if they do not have substantial income the organisation may be affected, enough profit may not be made, and the company will become bankrupt. For example, a business was investing ï¿½20,000 and each year the business generated ï¿½4,000 it would take 5 years to pay back the initial set up cost. The advantages of the payback method are that is quite simple to apply, this method is appropriate when technology is changing as it is now days. This technology can become very helpful to organisation and it would be very helpful for them to create documents and other business related documents.