Investment Techniques Assignment Help
For a business it is crucial for undergoing critical investment appraisal before any decision is undertaken considering specific capital investment. Such sort of appraisal is initiated by senior management officials of the organization and they have also been the part of strategic decisions. On the other hand tactical and operational decisions remains with the middle and junior mangers who have been seen to be responsible for things that need to be done for ensuring that things are done in an appropriate manner. Even it cannot be the ignored that decision making process of the company remains with senior authorities of the business. This essay will discuss and critically evaluate the four investment appraisal technique. It is also going to recommend about the best investment appraisal technique that can be taken into practice.
For understanding this aspect in an effective manner there is a need for exploring capital investments appraisal. It comprises of techniques that are seen to be traditionally applied within principle of economics for the purpose of asset replacement and expansion decisions. It has been defined by (Andrew.et.al., 2013) that capital budgeting is all planning for the long term decisions with respect to projects or business programmes. Arrow and Kruz, (2013) indicated that capital budgeting can also be termed as a process for the evaluation and selection of long term investments that are consistent with organization goals for maximizing the wealth of owners. For a business it is crucial for adopting appropriate investment appraisal techniques as failure in adopting right technique will be leading business towards devastating consequences. This essay has undergone four main investment appraisal techniques that can be undertaken within the business.
Payback is a most crucial method that can be used by business for evaluating their capital investment proposals that is required to be purchased especially in the scenario when future cash flow of the organization also becomes difficult to be predicted (Donovan and Hanney, 2011). It is a method that assumes that risk is time bound and therefore greater the period of risk taking the more the chances of its failure. Gorshkov.et.al., (2014) indicates that payback period is a method that can be used a technique for measuring risk based upon the longer the project takes for the payment the greater the risk associated with it. Even it has been identified that this technique has potential of providing results in a particular time period and allows most of the managers to consider this method. This technique can also be used by managers for indicating success especially in a scenario where performance of managers is measured using short term criteria. Thus, it can be stated that payback period method is one of the popular method that is used by managers for planning their investment projects.
Another investment appraisal technique is about accounting rate of return and it is considered to be the most important method for capital investment purpose. Gorshkov.et.al., (2014) indicated that it is a method that helps in measuring the return that can be earned out of a project in terms of income instead of undergoing project cash flows. The formula used for the calculation of accounting rate of return is Accounting rate of return = Average income/Average investment. For this purpose it is important to note that the above formula will not be similar in case of cash flows. It has also been found that majority of the smaller enterprise prefer to undergo Payback method. It is especially seen to be in the case when there are limited cash flows. Even these businesses do not have highly skilled mangers for undergoing appropriate investments in the project. However, big organizations do not have any reason to worry about such type of predicaments (Magni, 2010). Despite popularity of payback period it has been observed that this method has been flawed all due to failure of considering time value of money. However, this is not the case with that of accounting rate of return.
Further, Net Present Value (NPV) is and another investment appraisal technique. The NPV is calculated on the basis of estimation that how profitable a project will be before undertaking its start off. Further, in other words before undergoing a project the investor will be carrying out an estimation of the profits from the proposed project (Gollier, 2010). It is very important to compute the proper estimation of the profitability out of the project or investment while making any of the investments. The method includes the initial investment which shows a negative flow of cash as instead of coming in it shows the money going out. It considers that the money which is going out is been deducted from the incoming sum amount of cash flow and with respect to a valuable investment the net present value must be positive.
Finally, the internal rate of return is another technique which is used to carry out the capital investment appraisal. It is frequently used for investment decisions by managers and practitioners. It is considered as discount rate or annualized effective compounded return rate which produces the net present value for both positive and negative cash flow from a specific investment equal to zero (Magni, 2010). The condition of IRR for approving an investment to adopting a plan if the IRR is greater than the invested capital cost and to provided grade to the rival projects by their IRRs in which higher project has the higher IRR rank. Sometimes, this technique is used as (DCFROR) discounted cash flow rate of return, (ROR) rate of return or as the effective interest rate. The term internal is generally utilized to indicate the integration of external aspects such as the rate of interest and inflation. Fundamentally, The IRR is calculated by the evaluating the rate of interest in which cost’s of net present value of any provided investment is equivalent to the net present value of the profits of the savings. The IRR of new project should not exceed a required return rate of company. Where this occurs, the project will be considered as undesirable and should be refused. Following rule briefly explains that how IRR works: 0= P0+ P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n where P0, P1, . . . Pn equivalent to the cash flow in periods 1, 2, …n, correspondingly; and IPP is similar to the internal return rate of project.
From the above discussion it can be recommended that the investment appraisal technique that can be used by business for their best practices could be payback period. It is because it is the simplest and easiest method for the purpose of understanding and for computing the most important project. This method is also seen to be accepted by all kind of enterprise and is also easy for understanding. It has also been observed that this technique lays down emphasis on liquidity for carrying out the decision making process for the purpose of investment. Even it has been found that it is a method deals with risk. In this respect it can be said that project which has got shorter payback period will be having lesser risk when compared with the project having higher payback period. Even the short term approach concerning payback period lays down advantage for the calculation of capital expenditure. Even it is a technique used by business for evaluating their capital investment proposals that is required to be purchased especially in the scenario when future cash flow of the organization also becomes difficult to be predicted. It is a method that assumes that risk is time bound and therefore greater the period of risk taking the more the chances of its failure. This is also said to be a technique for measuring risk based upon the longer the project takes for the payment the greater the risk associated with it. It is even seen to be a method that has potential of providing results in a particular time period and allows most of the managers to consider this method. Hence, it can be said that business can make use of payback period method for carrying out their investment projects in a most significant manner.
Further, it can be said that payback method is also seen to be poplar in for undergoing business analyst. It has been seen that business has been make use of their teams of staff that are from varied backgrounds for undertaking evaluation of the project. The payback method helps out business in the reduction of simple number of years for understanding this concept. It is seen to be a best practice as it is a fast method for the calculation of return on investment particularly important for the organization which has got limited cash who want to recover their capital in a faster pace. This technique is used by managers for undertaking quick evaluations of projects that undergo smaller investment. Under such small projects there will not be involvement of a group of employees and it will also not be requiring rigorous economic analysis.
Books and journals
Andrew, J. P., Sirkin, H. L. and Butman, J. 2013. Payback: reaping the rewards of innovation. Harvard Business Press.
Arrow, K. J. and Kruz, M. 2013. Public investment, the rate of return, and optimal fiscal policy (Vol. 1). Routledge Publisher.
Brief, R. P. 2013. Estimating the Economic Rate of Return From Accounting Data (RLE Accounting) (Vol. 16). Routledge Publisher.
Creemers, S., Leus, R. and Lambrecht, M. 2010. Scheduling Markovian PERT networks to maximize the net present value. Operations Research Letters. 38(1). Pp. 51-56.
Donovan, C. and Hanney, S. 2011. The ‘Payback Framework’explained.Research Evaluation. 20(3). Pp. 181-183.
Gollier, C. 2010. Expected net present value, expected net future value, and the Ramsey rule. Journal of Environmental Economics and Management. 59(2). Pp. 142-148.
Gorshkov, A. S., Rymkevich, P. P., Nemova, D. V. and Vatin, N. I. 2014. Method of calculating the payback period of investment for renovation of building facades. Stroitel’stvo Unikal’nyh Zdanij i Sooruzenij. (2). Pp. 82.
Magni, C. A. 2010. Average internal rate of return and investment decisions: a new perspective. The Engineering Economist. 55(2). Pp. 150-180.