LONDON SCHOOL OF COMMERCE

(MBA FOUNDATION PROGRAMME)

September 2010

ASSIGNMENT ON
Accounting and Decision Making Techniques

Submitted To:
S. Palan,

Lecturer, London School of Commerce

Submitted By:
NAME & STD. ID NO:-

Ferdous Azam

L0203RBRB0610

MFP-B

Date of submission: August 17, 2010

MBA Foundation Programme

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 Assignment Topic

Investment Appraisal should add value to the business organization. Do you agree?
Critically analyze the main discounted cash flow techniques available to management.

Answer to the question no: 01

Nowadays, there are many business organization value method for assessing project volume
namely ratio analysis, cost- volume -profit analysis etc. One thing is Investment appraisal.
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Personally, I think that investment appraisal have to append measurement to the organization
in business.

As a common rule, investment appraisal i.e. capital budgeting is preferable to business when
its return on investment is larger than the cost to the business of giving that the cash to
creating the investment. Thus, to decide whether an investment appraisal is suitable, a
business in organization has to complete four steps: First, the company have to decide the
early cash payment required to make the investment. Second, business in organization has to
estimate the upcoming cash receipts and disbursement (cash flows) accepted from the
investment and the time period over which is anticipates these future cash receipts and
payments to happen. Third, the company have to determine its cost of giving the cash to
construct the investment. Finally the company have to determine whether the estimated
prospect cash flows will provide it is a return that is adequate to envelop the cost of providing
cash to compose the investment.( Accounting information for Business decision, Author :
Billie M. Cunningham, Loren A. Nikolai, John D.Bazley, page 716 )

There are many reasons for appending worth of investment appraisal in business institution.
First of all, Investment appraisal approves project for time-consuming term basis (Financial
management for decision makers - Page 149 by Peter Atrill - 2005).As a result, the firm
becomes tied to the project and loses some of its flexibility during that period. Second of all,
it can help the manager by performing as a showing tool in weeding out investment proposals
(by Stephen Lumpy, Chris Jones - Fundamentals of investment appraisal - 273 pages).
Furthermore, it helps manager for making the decision to purchase an asset so that managers
can predict the revenue over the life of that asset. (From Investment Performance
Measurement: Evaluating and Presenting Results, by Philip Lawton, Todd
Jankowski)Moreover, it establishes realistic project budgets. For the reason that it performs
to assess whether it is valuable formulating an investment. Finally, it measures Risks arising
from the investment so that it can be taken to eradicate the risks, decrease their impact.
(Investment Performance Measurement: Evaluating and Presenting Results - Page 59 by
Philip Lawton, Todd Philip Lawton, Todd Jankowski)

For measuring to the business organization, investment appraisal has different kind of
discounted cash flow techniques namely net present value, internal rate of return. Each
method indicates which one is the most money making development. Net present value is a
pointer of how much worth an investment or project includes to the firm. So, it is one move
towards to assessing whether or not to undertake an investment appraisal. The principle of
NPV is that NPV permits contrast of an investment by charging cash payments on the project
and cash receipts expected to be received over the lifetime of the investment at the similar
point in time, i.e. the present. (Principles of corporate finance, by Richard A. Berkley,
Stewart e. Myers, Franklin Allen, Ninth edition, Page 426). The NPV method identifies that
cash obtained at present is favourable to cash receivable a short time in the future. There is
further risk in containing to remain for upcoming cash receipts and whereas a lesser amount
may be attained now, at any rate it is accessible for other reasons.There are some causes for
liking better net present value method as an investment appraisal. The most vital reason is
that NPV emphasizes the significance of liquidity by the use of net cash flows .Moreover,
another important motives is that it recognizes time value of money into analysis of projected

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investment appraisal (By Stephen Lumpy, Chris Jones - Fundamentals of investment
appraisal - 273 pages). Besides, it is easy to compute whether the cash flows from an annuity
or contrast from time to time that it indicates to compare the NPV of different projects and to
reject projects that do not have a preferable NPV.

Another method of investment appraisal associated with discounted net cash flow is
identified as the internal rate of return. The internal rate of return is the money off rate that
discounted cash inflows total equals the discounted cash outflows so that the NPV is zero as
well as involves a trial-and-error method for solution. Internal rate of return has several
causes as an investment appraisal in an organisation. Firstly, the internal rate of return moves
towards completely accounts for the value of money and regards as all cash flows for the
project life. (Accounting information for Business decision, Author: Billie M.
Cunningham, Loren A. Nikolai, John D.Bazley, page 722)Secondly, the foremost reason is
that it is straight comparable to challenging applies of funds.IRR can be compared to the
yield of other projects. It can also be applied to decide the most favourable capital budget by
ranking projects in terms of their IRR and comparing them to the marginal cost of capital.IRR
can also offer a proposal of the “cushion” in a project. If, such as, a project has an IRR of
15% and the cost of capital is 12%, the cushion is 3%. (From Managerial Accounting, by
Don R. Hansen, Maryanne M. Mowen, 2006).Thirdly, the internal rate of return provides
safety margin information to management. It indicates how much the return on a project
could fall in percentage terms before it commences to destroy firm value. Last but not least,
some manager likes the internal rate of return because they prefer dealing with percentage
rates of return higher than with the dollar values in NPV. For the reason is that the internal
rate of return defines a percentage rate of return, managers can simply compare the internal
rate of return to the firm’s minimum suitable rate of return or trouble rate when making
investment decisions. (By Eugene F. Brigham, Philip R. Daves, Intermediate financial
management).

Investment appraisal decision may concern the following: 1. the achievement or surrogate of
long-standing assets, for instance buildings and plant.2.the investment of finances into a
different firm from which returns will surge.3.a special project which will affect the firm’s
future receiving capability such as a make enquiries project or a marketing operation.4.The
extension of the range of activities of the firm involving a capacity outlay, such as a new
production line or indeed a new project. So investment appraisal cover two aspects of long-
range productivity ; first, approximating the future and increases in cash inflows or net saving
in cash outlays which will outcome from the investment and second the total cash outlays
requisite to upshot the investment.( Accounting theory and practice, seventh edition by
MWE GLAUTIER and B. UNDERDOWN, page 486).

In conclusion, I would say that investment appraisal can allow manager to build an informed
preference concerning the possibility of the project i.e. it examines project whether this
project is acceptable in organization or not. Two Investment method i.e. Net present value
and internal rate of return, these two mainly significant methods of investment appraisal are
related with each other. However, they are interpret in a different way and are observed in a
range of perspective. In the last part the crucial factor is valuing the decision of the

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shareholders whereas corresponding what is the mainly important capital good. Investment
appraisal is an executed of structure the correct identify for upcoming intensification

Answer to the question no: 02

Required: A

Project: 01

We Know,

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Net present value = Net Cash Flow × Annuity Factor – Initial Investment

⇒ Net present value= £ 100,000 × 5.216 – 449,400[14%cost of capital]

So, Net present value=72200

Again,

Net present value = Net Cash Flow × Annuity Factor – Initial Investment

⇒ Factor of the Internal rate of return = 449400/100000

So, Factor of the Internal rate of return= 4.494

Looking in Table and Scanning along the 10 period line and we find that Factor of the
Internal rate of return 4.494 represents an internal rate of return 18%.

A. Internal rate of return 18%.

B. Net present value= £72200

Project: 02

We Know,

Net present value = Net Cash Flow × Annuity Factor – Initial Investment

⇒ 0 = £ 70,000 × Annuity Factor – Initial Investment

⇒ Factor of the internal rate of return = Initial Investment/70000

⇒ 4.192= Initial Investment/70000 [20% internal rate of return ]

⇒ Initial Investment=70000×4.192=£ 293440

Again we know,

Net present value = Net Cash Flow × Annuity Factor – Initial Investment

⇒ Net present value = £ 70000 × 5.216 – £ 293440[14% cost of capital]

So, Net present value = £ 71680

C. Initial Investment=£ 293440

D. Net present value = £ 71680

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Project: 03

We Know,

Net present value = Net Cash Flow × Annuity Factor – Initial Investment

⇒ 0 = Net Cash Flow × Annuity Factor – £ 200000

⇒ Annual net Cash Flow=£ 200000/ 5.216 [14% internal rate of return]

So, Annual net Cash Flow= £ 38344

Again,

Net present value = Net Cash Flow × Annuity Factor – Initial Investment

⇒ 35,624 = £ 38344 × Annuity Factor – 200000

⇒ Factor of Annuity= 235624/38344

So, Factor of the Internal rate of return= 6.1450031

Looking in Table and Scanning along the 10 period line and we find that Factor of annuity
6.1450031 represents cost of capital 10%.

E. Annual net Cash Flow= £ 38344

F. cost of capital 10%

Project: 04

We Know,

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Net present value = Net Cash Flow × Annuity Factor – Initial Investment

⇒ 5.650= £ 339000/ Annual net Cash Flow[12% cost of capital]

⇒ Annual net Cash Flow=£ £ 339000/ 5.650

So, Annual net Cash Flow= £ 60000

Again,

Net present value = Net Cash Flow × Annuity Factor – Initial Investment

⇒ 0 = £ 60000× Annuity Factor – 300000

So, Factor of the Internal rate of return= 5.00

Looking in Table and Scanning along the 10 period line and we find that Factor of the
Internal rate of return 5.00 represents Internal rate of return 15%.

So, Internal rate of return =15%

G. Annual net Cash Flow= £ 60000

H. Internal rate of return 15%.

Required: B

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We can see from the solution that it indicates different decision. The following are comparing
decisions for mutually exclusive project 1, 2, 3 and 4 as given below.

Method Project 1 Project 2 Project 3 Project 4 Decision law : Decision

Accept

Net present £ 72200 £ 71680 £ 35624 £ 39000 Higher positive Accept

value(NPV) NPV project 1

Internal rate 18% 20% 14% 15% Higher Accept

of percentage of project 2
return(IRR) IRR

Cost of 14% 14% 10% 12%

capital

Above the table, we can observe that project 1 would be satisfactory or preferable because its
net present value is superior to other project net present value. Because, projects 1 net present
value is £72200. But that project 2 should prefer because its internal rate of return (20%) is
superior to other project internal rate of return. This defines project 2 internal rate of return
surpasses the cost of capital (14%) applied to investment the project, the surplus return
remnants to increase shareholders returns and capital.

We can observe that from table that there is argument in ranking happens between IRR and
NPV. So, Which project we would prefer ?We have to remind that only the Net Present
Value choice statute will always lead to the accurate decision when preferring among
Mutually Exclusive Projects. It causes the Net Present Value as well as Internal Rate of
Return result policy differs with high opinion to their Reinvestment Rate supposition. Since
each project is likely to have a unlike IRR, the theory essential the Net Present Value
assessment rule is added logical. Hence, project 1 should prefer as its net present value (£
722000) is greater than other project net present value.

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References:

Books In –Text Example References list example Reference

type

2 Author Investment appraisal covers two aspects of Accounting theory and

long-range productivity; first, practice, seventh edition Book
approximating the future and increases in by MWE Glautter and B.
cash inflows............ by MWE Glautter and Underdown, page 486.
B. Underdown, page 486.
As a common rule, investment appraisal Accounting information
i.e. capital budgeting is preferable to for Business decision, Book
2 Author business when its return on Author : Billie M.
investment........by Billie M. Cunningham, Cunningham, Loren A.
Loren A. Nikolai, John D.Bazley Nikolai, John D.Bazley,
page 716
Net present value is an indicator of how Principles of corporate
Single much value an investment or project finance, by Richard A.
Author includes to the firm. So, it is one approach Berkley, Stewart e. Book
to measuring whether or not to undertake Myers, Franklin Allen,
an investment appraisal....... by Richard A. Ninth edition, Page 426
Berkley, Stewart e. Myers, Franklin Allen,
Ninth edition
There are a number of appraisal measures Investment Performance
2 Author that explicitly take the volatility of returns Measurement: Evaluating
into account. A widely accepted principle and Presenting Results - Book
of investment management theory and Page 59 by
practice is that investors are risk averse Philip Lawton, Todd
and therefore require...by Jankowski
Philip Lawton, Todd Philip Lawton, Todd
Jankowski - 2009 Jankowski - 2009
The additively of net present values of Contemporary Financial
independent projects is referred to in Management - Page 330
3 Author finance as the value additively principle. By R. Charles Moyer, Book
The net present value approach also James R. McGuigan,
indicates whether a proposed project will William J. Kretlow -
yield the rate of return required by ... 2009
Contemporary Financial Management -
Page 330

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Bibliography:

 Investment Performance Measurement: Evaluating and Presenting Results, by Philip

Lawton, Todd Jankowski

 Accounting Theory & Management Accountancy, By- Gokul Sinha

 Jae K. Shim, Joel G. Siegel Schaum's outline of theory and problems of financial
management.
 Financial management for decision makers - by Peter Atrill – 2005
 Fundamentals of investment appraisal by Stephen Lumpy, Chris Jones

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