Investment appraisal helps in figuring out the opportunities that can be derived from a certain investment. The main step of investment appraisal is a determination of possible outcomes that can derive from the investment by the company. A careful appraisal of investment helps in figuring out the rewards and risks that are available in the investments of the company. In this report, investment feasibility of the investment done by the company Stevenage Technologies limited is shown with the detailed findings. Further, the report focuses on the sources of income that can be opted by the company for proposing bank loan.
In the report, mainly the investment appraisal methods like net present value method, accounting return method, payback method, profitability index method are to be used for analysing the methods of investment appraisal. Recommendation based on the suitability of the investment methods are provided in this report.
Investment methods that are used for measuring the feasibility of the investment are divided into following categories:
Net present value:
In this method of investment appraisal, the difference between the present values of cash inflows over the present value of cash outflows is termed as the net present value related to investment. According to Vernimmen et al. (2018, p. 267), higher the net present value more feasible is the investment for the company. The investment with higher NPV is profitable for the company. In the report, the cost of capital is taken to be 12%. Therefore, a discount factor of 12% is to be taken for the analysis of the proposed investment. NPV investment methods take into consideration cost of capital and other risk inherent factors that help in making proper projections of the future. Net present value is to be calculated for 6 years with discounting factor of 12%. Total cash inflow for the project is £ 798190. The investment for the asset replacement requires an investment of £ 780000. The cost of asset replacement is assumed to be of £ 780000. The net present value of the asset replacement project is £ 18190. Net present value has generated the positive value of £ 18190. As positive value is generated from the project, therefore, the project can be accepted easily.
Cash out a flow of the project needs to be calculated after adjusting the initial investment with the increasing working capital of £ 200000. Total initial investment is taken to be £ 580000 and further add to the increased working capital of £ 200000 net outflow of the project is estimated to be of £ 780000.
The acceptance and rejection of the project depend on the Net present value generated from the project. The condition for selection of the project by the help of NPV depends on the three conditions.
Stevenage Techno Ltd is opting for replacement for expanding production. The cash inflow results have reported total cash inflow of £ 798190. Therefore, in order to opt for replacement option positive NPV generation is essential. Moreover, while calculating Payback period total cumulative cash flows of the business is matched with total cash inflows, which shows that within the range of £ 730000 to £ 975000 the cash outflow is to be calculated. Therefore, for matching with the total cash inflow it is assumed that the help of financing 4-year bank loan at 11.5% interest does initial investment of £ 580000. Initial investment is done for £ 580000, as total cost of machine is £ 1.8 million, which is not the immediate cost. Therefore, assumption of cost for initial investment is taken as £ 580000. For generating positive NPV initial investment is taken at £ 580000.
Therefore, based on the analysis of the project, as a net present value of the asset replacement is positive, therefore, the project of asset replacement is profitable for Stevenage Techno Ltd.
Accounting return method
According to Arrow and Kruz (2013, p. 24), in accounting rate of return method, the average accounting profit is divided by the average investment to estimate the return that could be generated from the investment. In the average accounting return method, then the project is mainly accepted when the ARR is greater than or equal to accounting rate of return. Accounting rate of return targeted by the directors as 14%.The calculation based on the average accounting return shows that on adding the cash flows of the organisation and divided by 6 years has generated an annual profit of £ 205000. The average investment for the project is (780000/2) = £ 390000. The ARR of the project is 52.5641. Decision criteria of the project acceptance depend on the rate of ARR generated by the company. As the ARR of the project that is calculated actually is more than the minimum targeted return (14%) therefore, the project of asset replacement is highly profitable for the company.
Arrow, K.J. and Kruz, M., (2013). Public investment, the rate of return, and optimal fiscal policy (Vol. 1). Routledge: Abingdon
Baum, A.E. and Crosby, N., (2014). Property investment appraisal. John Wiley & Sons: UK
Burchardt, J., Hommel, U., Kamuriwo, D.S. and Billitteri, C., (2016). Venture capital contracting in theory and practice: implications for entrepreneurship research. Entrepreneurship Theory and Practice, 40(1), pp.25-48.
Hsu, D.K., Haynie, J.M., Simmons, S.A. and McKelvie, A., (2014). What matters, matters differently: a conjoint analysis of the decision policies of angel and venture capital investors. Venture Capital, 16(1), pp.1-25.
Robb, A.M. and Robinson, D.T., (2014). The capital structure decisions of new firms. The Review of Financial Studies, 27(1), pp.153-179.
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