Chapter 24 Summary Capital Investment Appraisal PDF

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Download Chapter 24 Summary Capital Investment Appraisal PDF

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Chapter 24 Summary: Capital Investment Appraisal

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Capital investment appraisal is the application of a set of methods of quantitative analysis which give guidance to managers in making decisons as to how best to incest long term funds. Four Methods of quantative analysis in the chapter: Payback period is the length of time required for a stream of net cash inflows from a project to equal the original cash outlay Accounting rate of return is calculated by taking the average annual profits expected from a project as a percentage of the capital invested. The process of calculatinf present value is called discounting. The interest rate used is called the discount rate. The net resent value method of investment appraisal and the internal rate of return method are both based on discounting. Net present value of a project is equal to the present value of cash inflows minus the present value of the cash outflows, all discounted at the cost of capital. The decision rules are: a. Where the net present value of the project is positive, accept the project b. Where the net pesent value of the project is negative, reject the project c. Where the net present value of the project is zero, the project is acceptable in meeting the cost of capital but gives no surplus to its owners. The internal rate of return (IRR) is the discount rate at which the present value of the cash flows generated by the project is equal to the present value of the capital invested, so that the net present value of the project is zero. The decision rules are: a. Where the IRR of the project is greater than the cost of capital, accept the project. b. Where the IRR of the project is less than the cost of capital, reject the project. c. Where the IRR of the project equals the cost of capital, the project is acceptable in meeting the required rate of return of those investing in the business but gives n surplus to its owners. Mutually exclusive projects are found wherever a choice is needed because of limited resources of capital, labour, materials or any other constraint. Profitability index may be used to rank projects in situations of capital rationing or mutually exclusive projects Effective capital investment appraisal requires control procedure to be in pace for establishing the suitability of a project and for post completion audit to evaluate the success of the project Advanced manufacturing technologies have led to a demand for new ways of evaluating investment projects because new projects may require continous investment of resources rather than a single outlay at the outset...