Essay: Investment Appraisal For Long-term Operations.

Investment Appraisal Techniques

The assessment provides information regarding the investment projects that are being presented to the organisation for adequately conducting its operations in the long run. Analysis directly evaluates different Investment Of Result Techniques, which can help in analysing the investment proposal and help the organisation to select the best possible measure that can improve the return in the long run. The techniques such as net present value, internal rate of return, payback period and return on capital employed directly allow the organisation to detect the levels of benefits that the project would provide to the organisation. In addition, with these investment appraisal techniques, the organisation is able to segregate opportunities on the basis of returns and cash inflow which can eventually help in selecting the best possible investment option in the pool of investment proposals that is provided to the organisation. Furthermore, adequate information regarding foreign exchange risk conditions and the sources of finance is provided to the company for conducting the investment in the organisation.

The above table provides information regarding the cash flow projections of the investment proposal over the period of the next 5 years. In addition, the tables also provide data regarding the discounted rate that is needed to be used for discounting the overall cash flows of the proposed project. Hence, the overall data directly in the case that the cash flow conditions of the company are positive during the first 4 years as in the 5th year due to the payments in tax the overall cash flow is negative. However, the cash flows are derived by adequately evaluating different segments of expenses and contributions that are affecting the overall operations of the investment proposal (Almarri and Blackwell 2014). The overall addition of working capital along with the expansion machinery and income from scrap value is introduced in the cash flow to determine the actual cash inflow of the company over the period of 5 years. Further analysis is based on the cost of capital, which is derived by utilising the weighted average cost of capital method that utilises all the data from ordinary shares, debentures, bonds and preference shares of the organisation. The cost of capital for the organisation is calculated to be at the level of 10.43%, which would be used for discounting the overall cash flows derived in the above table.

The information presented in the above table directly indicates about the next present value calculations, which utilise the time value of money to determine the present value of future cash flows. From the overall analysis, it is detected that the discounted cash flow position of the company calculated in the above table is positive, which makes the net present value at the level of £692,090.71. Thus, it directly indicates that the investment proposal that is presented to the organisation is financially viable, as the future cash flow's present value is higher than the initial investment of the project. Therefore, it could be understood that utilising the investment proposal would be beneficial for the organisation in the long run as a tool to increase cash inflows and profits for the company.

Foreign Exchange Risk and Sources of Finance

Internal Rate of return:

Internal rate of return calculations is provided in the above table, which directly helps in detecting the minimum level of returns that the project is providing the organisation. The data is directly used by the company to understand the maximum level of cost of capital that the organisation could select to get a positive valuation from the project. Hence, the company utilising a discounting rate of 13.51% would achieve zero in NPV value, which indicates no profit or loss generator from the overall operations in terms of investment position (Throsby 2016). Thus, the internal rate of return is higher than the discounting rate of 10.43%, which states that the project is financially viable for investment purposes.

The organisation requires a payback period of 4 years from the overall venture. However, the above calculations indicate that the payback period of the investment proposal is at the level of 3 years, which is lower than the anticipated requirement of the organisation. Pawlak and Zarzecki (2020) argued that the payback period does not utilise the time value of money and all the cash flows of the project, which increases discrepancies in the decision-making process. Therefore, according to the payback period conditions the project should be accepted as it allows the company to get the overall investment back within 3 years, which is lower than the assumed value of 4 years by the organisation.

The information presented in the above table directly indicates about the return on capital employed by the organisation, which is calculated by utilising the average profits and initial investment of the project. The average profit of the organisation is directly identified by adding all the profits incurred during the four-year period while dividing it by the number of years the project is used. However, the return on capital employed also utilizers the 5th year negative profits for the project as payments need to be done, as it is required to be in one year arrears (Ayodele 2019). Thus, the ROCE is at the level of 23.58% for the project, which indicates that investment needs to be done in the project.

There is a potential impact of changes on the project as the overall requirement of the investment directly indicates that the production would be exported to the eurozone and USA under equal units. Therefore, the company would generate revenues in the form of Euros and dollars in contrast to the actual GBP used in the production process. The conversion of euro and USD into GBP would hinder the overall future cash flows of the company if the foreign exchange were high during the conversion period. Therefore, the risk of foreign exchange rate conversion is relatively high as without adequate levels of heading process the company would not be able to maintain the anticipated cash flow, which in turn can reduce the financial viability of the project and force the organisation to face losses in the long run. Hence, the overall analysis indicates that the organisation should use hedging measure for curbing the losses incurred from cash inflows in USD and Euro, which needs to be converted into GBP to determine the actual profits and cash flows from the project. Thus, forward contractions, options contracts and futures contracts can be used for the organisation to hedge its exposure in USD and EURO.

Cash Flow Projections

The analysis of the overall investment required in the project is relatively nominal in terms of investment capital. Therefore, it is recommended that utilising either of the preferred sources of finance for the project would be beneficial for the organisation. The first source of finance is retained earnings where the organisation could use the overall savings that are being conducted in the company over the period of time to initiate the project and have no influence of depth or equity on the new investment (Fokkema, Buijs and Vis 2017). Moreover, the second source of finance for the project could be used as a bank loan, as it would be easy for the organisation to gather the overall investment in a small time and start the project to generate higher returns in the long run. The overall capital structure of the organisation indicates that the maximum of the capital employed by the company is equity where debt can be used to improve the operational capabilities of the organisation. Thus, any combination of debt and retained earnings can be used by the organisation to accommodate the new project.

Several non-financial matters that need to be addressed by the organisation before initiating the project are the problems that the management would face with the new distribution system and the newly branded product. The implementation of the own distribution system with the newly branded product would hinder the existing distribution system and products of the organisation (Lefley 2018). Hence, the existing product and distribution system would have a negative impact and might force the company to incur losses in the long run. Furthermore, the management needs to address the overall new measures that it intends to take with the proposed investment project. Furthermore, building a new product would erode the profits and market share of the existing products of the organisation, which in turn would hamper future prospects of the company.

Conclusion:

The assessment provides information regarding the financial attributes of the investment proposal, which the company should consider before making any kind of investment decision. Who over the overall calculations of investment of result techniques has directly indicated the financial viability of the investment proposal, which can allow the organisation to maximise profits from the investment while reducing the total risk involved in foreign exchange. Attitude discussions regarding the foreign exchange risk on the project are conducted, which states that utilising the hedging measures that would help the organisation to minimise its exposure. Appropriate levels of alternative sources of finance are provided to the organisation, which can be used by the company to initiate the project and generate returns. Non-financial matters such as the development of new distribution systems and branded products can lead to the erosion of the current distribution system maintained by the company. Thus, adequate levels of measures need to be considered before initiating the project by the management. 

References:

Almarri, K. and Blackwell, P., 2014. Improving risk sharing and investment appraisal for PPP procurement success in large green projects. Procedia-Social and Behavioral Sciences, 119, pp.847-856.

Ayodele, T.O., 2019. Factors influencing the adoption of real option analysis in RED appraisal: an emergent market perspective. International Journal of Construction Management, pp.1-11.

Babatunde, S.P., 2016. Linear Programming and Investment Appraisal: A Review of Literature. American Journal of Management Science and Engineering, 1(2), pp.61-66.

Baum, A.E., Crosby, N. and Devaney, S., 2021. Property investment appraisal. John Wiley & Sons.

Fokkema, J.E., Buijs, P. and Vis, I.F., 2017. An investment appraisal method to compare LNG-fueled and conventional vessels. Transportation Research Part D: Transport and Environment, 56, pp.229-240.

Kengatharan, L. and Nurullah, M., 2018. Capital investment appraisal practices in the emerging market economy of Sri Lanka. Asian Journal of Business and Accounting, 11(2), pp.121-150.

Lefley, F., 2018. Dispelling the Myth Around the Financial Appraisal of Capital Projects. IEEE Engineering Management Review, 46(1), pp.47-51.

Milenkovi?, M., Švadlenka, L., Bojovi?, N. and Melichar, V., 2016. Railway Investment Appraisal Techniques. In Handbook of Research on Emerging Innovations in Rail Transportation Engineering (pp. 67-99). IGI Global.

Pawlak, M. and Zarzecki, D., 2020. Investment Appraisal Practice in the European Union Countries. European Research Studies, 23(2), pp.687-699.

Throsby, D., 2016. Investment in urban heritage conservation in developing countries: Concepts, methods and data. City, Culture and Society, 7(2), pp.81-86.