Investment Appraisal
On the basis of case study mentioned in the assignment, Casa Cocina is a producer of kitchenware and home appliances which was ascertained back in the year 2002 by the managing director. Thus, the company grew a reputation for manufacturing and designing superior quality domestic appliances. Its products are aspired at a high-end market & have grew a loyal, customer base, and demanding in the Europe and United Kingdom. The company enjoyed a growth of around 4% over the last few decade & the BOD is sure that the group has a convincing market position & is looking for chances in order to accelerate the expansions rate. Over the last two years, CCL has been testing and designing the new products and a new criterion should also be met. Furthermore, the directors have determined to instruct the food processor’s production in order to inflate the net profits & boost a festering sales growth.
The primary objective of this report is to undertake the project’s financial analysis by making use of the investment appraisal technique. An overview of the techniques usefulness has also been provided and the board anticipates information from the industry and academic sources with respect to the investment appraisal’s application and reliability. In addition, investment recommendation has been provided on the basis of calculation and an identification have also been discussed with respect to the risks related with the project, both non-financial and financial. A brief indication of the foundation of utilizing balanced scorecard as the management tool. Lastly, a conclusion has been provided on the basis of overall financial analysis and calculation, mentioned in the report.
Investment Appraisal refers to a method that the business would evaluate an attractiveness of possible projects and investments on the basis of financial techniques and capital budgeting findings (Aly and Mansour 2017). The techniques include analyzing or examining the project’s cash outflows and inflows to decide whether the anticipated return covers a set benchmark. Thus, the technique is mainly utilized by both public and private sector organizations & is the decision instrument in order to evaluate whether there is value with respect to investing in a certain purchase or project. It is a procedure of significant analysis because it may help in recognizing the long-term trends & company’s perceived profitability.
The three most important and significant techniques of investment appraisal are Net Present Value, Internal Rate of Return, & Return on Capital Employed. They are mainly meant to assess the new project’s investment, hence the following are mentioned & discussed below:
Net Present Value refers to a technique that is mainly used for financial analysis in deciding the businesses or projects investment feasibility (Adebimpe and Bashir 2018). It refers to a PV of all the future cash flows (negative and positive) over the whole life. Its analysis is a procedure of an intrinsic valuation & is mainly utilized extensively across accounting and finance for determining the businesses value, capital project, cost reduction program, investment security, new venture, & anything that includes cash flow. Additionally, if the investments or projects NPV is in negative then it implies that the predictable rate of return that would be earned is less than the hurdle rate or discount rate. This does not essentially mean that the project would “lose money”. However, it might well produce income (accounting profit), but since the ROR produced is less than a discounting rate, hence it is considered to be a destroy value. While, on the other hand, if the value of Net Present Value is in positive then it means that it creates a value.
Net Present Value
IRR (Internal Rate of Return) refers to a metric which is mainly used in the financial examination in order to approximate a potential investments profitability. It is a discounting rate that makes NPV (Net Present Value) of all the cash flows equivalent to zero in the analysis of discounted cash flow. Higher the IRR, the more valuable and attractive an investment is to commence. In addition, IRR is ideal for examining the projects of capital budgeting in order to comprehend and understand the potential rates annually. Moreover, it is computed by utilizing the similar concept as NPV excluding it sets the net present value equals to zero. This method is widely utilized in examining investments for venture capital and private equity, which includes many cash investments over a business life and cash flow with the help of businesses sales and IPO. Lastly, it is a great method to compare and evaluate the different investments returns.
ROCE is another method of capital budgeting that is mainly utilized in determining the possible profitability of the long-term investments over the stipulated period of time. By making ROCE, it would allow the investors in deciding the profitability and viability of the capital projects in order to be undertaken. Thus, it also assists investors in analysing the risk included in the investments & deduce if the investment will produce sufficient net earnings to meet the risk level. However, ROCE is calculated by dividing the average annual profit with its initial investment. It is extensively utilized financial metrics & comes handy throughout the process of decision-making when various projects are selected and compared. Hence, the calculation of ROCE ignores taxes, inflation, and the interest accrued, this creates it an inadequate method for long-term and huge capital investments. In addition, this method does not consider cash flows or TVM (Time Value Money).
Based on the case study provided in the assignment, it can be observed that the initial investment stands at -1300000 and working capital investment stands at -100000. Hence, the total investment is calculated at -1400000. Secondly, the budget units for the following five years have also been producing in order to calculate total revenue. The company also plans to sell new products to the retailers for the first three years of worth around £300 and for the last two years the cost reduces to around £280. Additionally, it can be seen that there is a reduction in the value of total revenue. The management accountant also approximates that every unit would take on average of around 4 hours in order to produce average production hours. Currently, production workers are paid around £18/hour, and is also anticipated to inflate by around 3 percent year on year. Finally, based on the production hours and labour rate, the total amount of labour cost is calculated (Baum, Crosby and Devaney 2021). Whereas, on the other hand, the cost of packaging would be around £4/unit for the first and second years but because of the requirement to decrease packaging waste, this price is anticipated to decrease by around 10%. The total packaging cost is computed by multiplying the packaging cost/unit with the budget units which stands at 12250 in the first year. In order to compute Profit Before Taxes, depreciation expense is calculated. Once PBT is calculated, 20% tax has been deducted to calculate profit after tax. Hence, depreciation expense, machines salvage value, and working capital release is being added in order to compute the total value of net cash flows. Then a discounting factor of around 15% is being multiplied with the total net cash flows to calculate the PV of cash flows for the following five consecutive years. Lastly, based on the line items that has been mentioned earlier, NPV, IRR, and ROCE is being calculated.
Internal Rate of Return
On the basis of investment appraisal techniques computation, it can be recommended to invest in CCL (Casa Cocina Limited) with respect to an expansion plan and hence the project shall be approved. This is due to the project which generate a positive net present value of worth around 406005.88 which is a complete value addition to shareholders. Moreover, the rate of IRR is high which stands at around 27.34% and it also surpasses the rate of cost of capital. Lastly, the ROCE is also stands at 27.73% and based on this, an investment is recommended from the financial viewpoint. Though, decisions should not be made on the basis of financial figures as management should also consider the non-financial components which are quite imperative in the techniques of an investment appraisal (Tan, Zhang and Khodaverdi 2017).
Risks arises from various sources, varying on the investment type being considered, and the situations & the industry into which the firm is operating or running (Babatunde 2016). The following sources of risks are discussed and mentioned below:
- Project-Specific Risk:It refers to that type of risks which are associated to a certain project and influences the cash flow of a project. Thus, it involves projects completion in scheduled time, estimation’s error in allocation and resources, cash flows estimations.
- Company-Specific Risk:It refers to such risk that occur because of the firm’s particular factors such as credit ratings downgrading, changes in the key managerial persons, and other laws & regulations, and cases for IPR (Intellectual Property Rights). All these factors influence entity’s cash flows and access to finance for the capital investments.
- Industry-Specific Risk:It refers to a risk that influence the entire industry into which the firm operates. Thus, these risks contain regulatory restrictions on sector, changes in the technology (Messeghem et al. 2018).
- Market Risk:It is referring to a risk which occur because of the market associated circumstances such as entry substitute, access and availability to resources, and an alteration in the demand conditions.
- International Risk:It refers to a risk which are associated with circumstances which are produced by the global economic conditions such as recessions, inflation, geographical conditions, limitations on the free trade, restrictions on market retrieve, political conditions, and bilateral agreements.
- Competition Risk:It is a risk which are associated with the market competition into which an organization runs or operates. Thus, these risks are the product dynamism, change in the preference and taste of consumers.
An organization might have multiple various objectives in their regular business operations. This is mainly made on the basis of discussions mentioned in the first part of this report (Kengatharan and Clamenthu 2017). It has the main purpose to lead business in such a way that it assists in maximizing the value of ownership or shareholders. However, there are respective non-financial objectives and is quite significant to not assess the financial performance measures but it also device the non-financial measures. Hence, the balanced scorecard framework presented by Norton and Kaplan in 1992 which participates both the performance measures by recognizing applicable key performance signs which may be related for achieving the particular set of purposes of an organization (Hasan and Chyi 2017). The tool also assists in measuring the strategic initiatives from four different viewpoints that is financial, customer, internal business, and learning & growth.
Balanced Scorecard refers to a strategic management performance that assists firms in enhancing & identifying their internal business operations in order to assist their external consequences. It measures or evaluates past performance data & delivers organizations with response on how to create efficient determinations in the future. Moreover, it delivers a powerful tool for communicating & building strategy. Its business model is visualised in the “Strategy Map” which assists managers to believe about the cause & effect relationships among the different strategic objectives. Moreover, balanced scorecard also assists organizations in mapping their projects and initiatives to the many strategic objectives, which ultimately assures that the initiatives & projects are firmly concentrated on providing the primary strategic objectives (Mehralian et al. 2017).
Conclusion
On the basis of above discussion, it can be concluded that investment appraisal is quite significant for the traders as it is a procedure of important analysis and is enough capable of demonstrating whether the company or stock has a long-term potential on the basis of profitability of its endeavours and future projects. Thus, investment determinations have the long-term suggestions on the profit capacity & growth rate of the company. These decisions would decide the company’s role in the upcoming period. The polite investment strategy would contribute to a considerable influx of funds.
References
Adebimpe, O.A. and Bashir, O., 2018. Modern approach to property development appraisal. Covenant Journal of Research in the Built Environment.
Aly, A.H. and Mansour, M.E., 2017. Evaluating the sustainable performance of corporate boards: the balanced scorecard approach. Managerial Auditing Journal.
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.
Hasan, R.U. and Chyi, T.M., 2017. Practical application of Balanced Scorecard-A literature review. Journal of Strategy and Performance Management, 5(3), p.87.
Kengatharan, L. and Clamenthu, D.P., 2017. Use of capital investment appraisal practices and effectiveness of investment decisions: a study on listed manufacturing companies in Sri Lanka. University of Jaffna.
Mehralian, G., Nazari, J.A., Nooriparto, G. and Rasekh, H.R., 2017. TQM and organizational performance using the balanced scorecard approach. International Journal of Productivity and Performance Management.
Messeghem, K., Bakkali, C., Sammut, S. and Swalhi, A., 2018. Measuring nonprofit incubator performance: Toward an adapted balanced scorecard approach. Journal of Small Business Management, 56(4), pp.658-680.
Tan, Y., Zhang, Y. and Khodaverdi, R., 2017. Service performance evaluation using data envelopment analysis and balance scorecard approach: an application to automotive industry. Annals of Operations Research, 248(1), pp.449-470.
Zarzecki, D. and Pawlak, M., 2020. Investment appraisal practice in the European Union countries.
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