Investment Appraisal

• Capital Investment Appraisal

  The process of evaluating the profitability and viability of a proposed capital investment project
• Methods used to evaluate investment proposals

  • Payback Period Method
  • Net Present Value Method
  • Accounting Rate of Return
  • Other methods
• Discount rate

  The rate used to calculate the present value of future cash flows
• Net Present Value (NPV)

  Present value of all cash inflows less cash outflows
• Net Present Value Method

  • Accept (in case of single project) if positive (wealth creation)
  • Reject if negative NPV
  • In case of mutually exclusive projects, accept the project that gives the highest NPV
  • Never accept the project that gives negative NPV (wealth destruction)
• If NPV is negative

  It is wealth destruction
• Multiply Cashflows with discount factor to calculate NPV
• NPV is one of the widely used and most acceptable methods of Capital Investment Appraisal in real life
• Advantages of NPV

  • considers time value of money
  • clarity in decision making
  • shows long-term profitability of project
• Disadvantages of NPV

  • used estimated capital cost and cash inflow values
  • only considers financial aspect, not external or macro-economic factors