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Investment Appraisal Techniques

Discuss about the Financial Viability Of The Project.

Particulars

Year 1

Year 2

Year 3

Year 4

Year 5

Sales Volume

                       200,000

                       300,000

                       450,000

                       225,000

                       112,500

Sales price

 $                              75

 $                              77

 $                              80

 $                              82

 $                              84

Revenue

 $              15,000,000

 $              23,175,000

 $              35,805,375

 $              18,439,768

 $                9,496,481

Cost of goods sold

 $                9,000,000

 $              13,905,000

 $              21,483,225

 $              11,063,861

 $                5,697,888

General and administrative expenses

 $                1,000,000

 $                1,050,000

 $                1,102,500

 $                1,157,625

 $                1,215,506

Rent

 $                    250,000

 $                    250,000

 $                    250,000

 $                    250,000

 $                    250,000

Depreciation

 $                3,000,000

 $                3,000,000

 $                3,000,000

 $                3,000,000

 $                3,000,000

Profit before Tax

 $                1,750,000

 $                4,970,000

 $                9,969,650

 $                2,968,282

 $                 (666,914)

Tax

 $                    525,000

 $                1,491,000

 $                2,990,895

 $                    890,485

 $                 (200,074)

Profit after Tax

 $                1,225,000

 $                3,479,000

 $                6,978,755

 $                2,077,798

 $                 (466,840)

Value

 $                4,225,000

 $                6,479,000

 $                9,978,755

 $                5,077,798

 $                2,533,160

Particulars

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Value

 $                4,225,000

 $                6,479,000

 $                9,978,755

 $                5,077,798

 $                2,533,160

Net working capital

 $              (3,000,000)

 $                3,000,000

Initial investment

 $           (15,000,000)

Cash Flow

 $           (18,000,000)

 $                4,225,000

 $                6,479,000

 $                9,978,755

 $                5,077,798

 $                5,533,160

Year

Cash Flow

Dis-factor

Dis-cash flow

Cum cash flow

Dis-Cum cash flow

0

 $ (18,000,000)

1

 $ (18,000,000)

 $ (18,000,000)

 $ (18,000,000)

1

 $ 4,225,000

 0.9091

 $ 3,840,909

 $ (13,775,000)

 $ (14,159,091)

2

 $ 6,479,000

  0.8264

 $ 5,354,545

 $ (7,296,000)

 $ (8,804,545)

3

 $ 9,978,755

 0.7513

 $ 7,497,186

 $ 2,682,755

 $ (1,307,359)

4

 $ 5,077,798

 0.6830

 $ 3,468,204

 $ 7,760,553

 $ 2,160,845

5

 $ 5,533,160

 0.6209

 $ 3,435,657

 $ 13,293,713

 $ 5,596,502

Particulars

Value

NPV

 $ 5,596,502

IRR

21%

Payback period

                  2.73 years

Discounted payback period

                  3.38 years

Profitability Index

                              1.31

 

To: The CEO (Pinto Limited)

From: Financial Analyst

Date: 19-05-2018

Subject: Analysing the new project and detecting its financial viability

Sir,

The financial viability of the proposal could be identified with the help of investment appraisal techniques, which allow the organization to gauge into the investment scope. Furthermore, the financial feasibility of the project is determined by evaluating the cash inflows and outflows conducted throughout the project life. The memo aims in identifying and highlighting the positive and negative attributes of the proposed project, which could allow Pinto Limited to improve its current financial position. The proposed project is prepared with the help of an external consultant, which helps in understanding the demand and prospects of the particular project. Adequate fees are paid to be Consultant for the services provided on the proposed project, while the expense is not recorded in the evaluation and is considered an expense of the organization and not the project. The expense is actually referred to as a sunk cost and cannot be attached with the proposed projects as initial investment (Li and Trutnevyte 2017).

Moreover, the setup location for the project is owned by the organization, which was previously let out for rent purposes. The company was getting current of $250,000 from the premises which will be used by the new project. Hence, the decision is taken to deduct the rental income that was generated by the company from the project to identify its actual financial viability. This would help in understanding the extra income that will be provided by the project if the premise was not used for rent purposes. Lastly, it is also assumed that the equipment and plant is depreciated every year and does not have any Salvage value after the completion of 5 years. Moreover, the cash flow that is generated from the project is at the end of the years which could help in analyzing the actual cash inflow obtained by a project (Kengatharan and Clamenthu  2017).

The analysis of investment appraisal techniques such as Net present value, internal rate of return, payback period, discounted payback period, and profitability index in the case of positive attributes of the project. The evaluation directly indicates that NPV of the project is the higher than zero, while the internal rate of return is higher than the cost of capital. Moreover, the payback period and discounted payback period is less than the project useful life, while the profitability index is greater than 1. The above attributes directly indicate a positive vibe for the new project, which would allow Pinto Limited to generate higher rate of return from investment.

Optimistic Scenario

Value

Unit sales growth

60%

Unit sales de-growth

40%

Price Hike

5%

NPV

$ 10,283,558.60

Pessimistic Scenario

Value

Unit sales growth

20%

Unit sales de-growth

60%

Price Hike

1%

NPV

$ (1,306,256.11)

However, conducting the uncertainty analysis such as scenario analysis and sensitivity analysis could eventually help in identifying the financial viability of the project. According to the scenario analysis, both optimistic and pessimistic scenarios are evaluated for the new project. This relatively helps in understanding the level of profits or losses, which could incur due to the changes in certain assumptions (Fokkema, Buijs and Vis 2017).

Snegative NPV, as the cash flow is not adequate to support rising discount rate of the company. From this revaluation it could be identified that the project will not increase up to a 21% discounting date and provides a question for the returns that will be generated from investment.

After analyzing all the Investment appraisal techniques, it could be identified that the project is a viable approach which could allow Pinto limited to maximize its profit overtime. Hence, the company should commence with the proposed project, as it delivers positive cash flow and will increase firm value in future.

Reference and Bibliography:

DeBoeuf, D., Lee, H., Johnson, D. and Masharuev, M., 2018. Purchasing power return, a new paradigm of capital investment appraisal. Managerial Finance , (just-accepted), pp.00-00.

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.

Hicks, C.L., 2017, July. MODERN PROJECT INVESTMENT APPRAISAL: RETURN TO SIMPLICITY. In Process Optimisation: A Three-Day Symposium Organised by the Midlands Branch of the Institution of Chemical Engineers and Held at the University of Nottingham, 7–9 April 1987 (No. 61, p. 53). Elsevier.

Hsiao, P.C.K. and Kelly, M., 2018. Investment considerations and impressions of integrated reporting: Evidence from Taiwan. Sustainability Accounting, Management and Policy Journal, 9(1), pp.2-28.

Kengatharan, L. and Clamenthu, P.D., 2017. Use of Capital Investment Appraisal Practices and Effectiveness of Investment Decisions: A Study on Listed Manufacturing Companies in Sri Lanka. Asian Journal of Finance & Accounting, 9(2), pp.287-306.

Laird, J.J. and Venables, A.J., 2017. Transport investment and economic performance: A framework for project appraisal. Transport Policy, 56, pp.1-11.

Li, F.G. and Trutnevyte, E., 2017. Investment appraisal of cost-optimal and near-optimal pathways for the UK electricity sector transition to 2050. Applied energy, 189, pp.89-109.

Lizieri, C., 2018. Property ownership, leasehold forms and industrial change. In Industrial Property (pp. 181-194). Routledge.

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[Accessed 12 June 2024].

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