Transcript Document

OHT 10.1
Making capital investment decisions
OBJECTIVES
You should be able to:
Explain the nature and importance of investment
decision making
Identify the four main investment appraisal methods
used in practice
Use each method to reach a decision on a particular
practical investment opportunity
Discuss the attributes and defects of each of
the methods
© Pearson Education Limited 2003
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
OHT 10.2
Business
Exhibit 10.1
Expenditure on additional fixed assets as a
percentage of:
Annual sales
Associated British Foods plc
Start of year fixed assets
10.1
28.6
The Boots Company plc
3.2
7.6
British Airways plc
9.3
7.0
19.9
17.0
5.0
20.1
J D Wetherspoon plc
25.1
24.1
Manchester United plc
27.5
20.5
Stagecoach Group plc
6.0
5.4
Tesco plc
8.5
20.1
79.4
11.8
BT plc
British Sky Broadcasting Group plc
Vodafone Group plc
© Pearson Education Limited 2003
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
OHT 10.3
Methods of investment appraisal
Four methods of
evaluation
Accounting rate of
return (ARR)
Payback period (PP)
Net present value
(NPV)
Internal rate of return
(IRR)
© Pearson Education Limited 2003
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
OHT 10.4
Accounting rate of return (ARR)
ARR =
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x 100%
Average annual profit
Average investment to earn that profit
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
Payback period (PP)
OHT 10.5
Payback period
(PP)
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The payback period is the
length of time it takes for the
initial investment to be repaid
out of the net cash inflows
from the project.
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
The cumulative cash flows of each
project in Activity 10.6
OHT 10.6
Initial outlay
Payback period
Project 1
Yr
1
Project 2
Yr
YY
11 2
Project 3
Yr
1
0
Yr
2
Yr
3
Yr
3
Yr
2
100
Yr
4
Yr
5
Y Y
4 5
Yr
3
200
Yr
4
300
Yr
5
400
500
600
700
800
900
Cash flows (£000)
© Pearson Education Limited 2003
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
OHT 10.7
The factors influencing the discount
rate to be applied to a project
Interest
foregone
Discount
rate
Inflation
Risk premium
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Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
Present value of £1 receivable at
various times in the future,
assuming an annual financing
cost of 20 per cent
OHT 10.8
£1
0
1
2
3
4
5
6
7
8
9
10
Years into the future
© Pearson Education Limited 2003
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
OHT 10.9
Why NPV is superior to ARR and PP
NPV fully addresses each of the following:
The timing of the cash flows
The whole of the relevant cash flows
The objectives of the business
© Pearson Education Limited 2003
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
OHT 10.10
Internal rate of return (IRR)
Internal rate of
return (IRR)
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The internal rate of return is the
discount rate, which, when
applied to the future cash flows
of a project, will produce an
NPV of precisely zero.
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
OHT 10.11
The relationship between the NPV
and IRR methods
70
NPV
(£000) 60
50
40
30
20
IRR
10
0
10
20
30
40
Rate of return (%)
© Pearson Education Limited 2003
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
OHT 10.12
Dealing with questions relating to
investment appraisal
Some practical points
Relevant cash flows
Year-end
assumption
Opportunity
costs
Interest
payments
Taxation
Other factors
Cash flow not
profit flow
© Pearson Education Limited 2003
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition
OHT 10.13
Investment appraisal in practice
Many surveys have tended to show:
Businesses using more than one method to assess each
investment decision
An increased use of the discounting methods (NPV and
IRR) over time
Continued popularity of ARR and payback period
A tendency for larger businesses to use the discounting
methods and to use more than one method
© Pearson Education Limited 2003
Atrill, McLaney: Accounting and Finance for Non-Specialists, 4th edition