Report Based on Decision Making Process, Pros & Cons of Investment Appraisal Method

Question :

The term financial management helps in operational activities so that marketing strategies can be carried out effectively. It comprises of trading and making income in exchange of the international currency. This report include the following questions as evaluated below:

  • Determine the use of the Investment appraisal method in order to assess project viability
  • Prepare report to the director for the financial information which is used in the decision making process, Pros & Cons of investment appraisal method
  • Evaluate the function of various ratios
Answer :

INTRODUCTION

International financial management deals with all financial decision made in the field of global business. It is said to be more popular concept which means administration of finance assignment in every environment. This consists of conducting trade and making income by the exchange of international currency. It assists manager of an organisation to link with global dealing with foreign business partners such as suppliers, lender and customer etc. This project report provides specific information about use of investment appraisal methods in order to assess the overall viability of mentioned projects. On the basis of calculation, suggestion would be made, whether company should undertake the project or go for other opportunities. Apart from this, other part of this report used to calculate various ratios in context to company a is discussed under this report (Madura, 2011).

PART A

Use of Investment appraisal methods to assess the viability of a project

In every organisation, it has been found that they use various types of methods and tools before selecting any kind of projects for further expansion. It is an evaluation of all investment proposal by the help of using various approaches such as average rate of return, Internal rate of return and net present value. It is considered as one of the important part of capital budgeting and application to areas in which return cannot be easily quantifiable. There are various types of investment appraisal techniques that can assist in overall analysis of any project. In order to make long term project, if the upcoming return is likely to be attain in near future time. The factors are chosen on the priorities of stakeholders and make appropriate decision in proper manner. In accordance to get complete image and proper understanding of capital investment techniques. Different types of capital investment tools that are employed to measure performance of the company (Sharan, 2012).

  • Net present value (NPV): This types of capital investment methods used to measure the cash inflows, whether extra or shortfall arises recorded by the company can be calculated by using this method. It is termed as difference among present value of cash inflows and cash outflows over a particular period of time are taken into account.

NPV= Cash inflows - Cash outflows

  • IRR (Internal rate of return): It is one of the important capital budgeting process which is used for the purpose of estimating the overall effectiveness for the potential investments. It is termed as discounted rate that used to make net present value of every cash flows from a specific project must be equal to zero. This happens to be predetermine tools used by managers for the purpose of evaluation of large projects and investment proposal used within an organisation.

IRR = R1 + (NPV1 x (R2 - R1)) / (NPV1 - NPV2)

  • Payback period: This seems to be effective method that determine total time required to get the investment amount back. It is the method considered for the purpose of calculating time required to earn back overall cost incurred in the investments by successive cash inflows. It used to measure capital budgeting tools that measure overall number of years taken to recovery all the capital investments (Brigham and Houston, 2012).

Payback period= Cost of project/investment / Annual cash inflow

In case company A gives 10% of return to their investors then the profit of company will be:

Time

Cash inflow ($000)

PV factors @ 10%

Cash outflows

Current year

-1200

1

-1200

Year 1

200

0.909

181.82

Year 2

250

0.826

206.61

Year 3

471

0.751

353.87

Year 4

456

0.683

311.45

Year 5

147

0.621

91.28

Year 5 ( scrap value)

100

0.621

62.09

Total present value

1207.12

NPV

$1,097.38

IRR

10%

Payback period

5 year

In case company A reduce the rate of return to 4% then they will be able to get their initial investment amount in 4 years.

Time

Cash inflow ($000)

PV factors @ 4%

Cash outflows

Current year

-1200

1

-1200

Year 1

200

0.962

192.3076923

Year 2

250

0.925

231.1390533

Year 3

471

0.889

418.7172849

Year 4

456

0.855

389.7907111

Year 5

147

0.822

120.8232847

Year 5 (scrap)

100

0.822

82.19271068

Present value

1434.970737

NPV

$1,379.78

IRR

10%

Payback period

4 years

In the 4th year

1231.955

Calculation of ROI

Particular

Amount

ROI ratio

Initial investment

-1200

Present value at 10%

1207.12

0.593333

Present value at 4%

1434.97

19.5

Report to the directors

Financial information used in decision making

There are various financial data regarding the nature and amount of reporting entity economic resources and claims can be providing strength and weakness of the company. some of them are mentioned underneath:

  • Ratio analysis: It is one of the quantitative analysis of data include in a company’s financial statement. It is used to evaluate different aspects of a business’s overall operating and financial information such as their efficiency, liquidity and solvency.
  • Income statement: This particular financial statements will provide more reliable information about company’s overall profitability and total net earnings during the time. Financial performance is being assessed through giving complete summary of how business generate their revenue and expenditure by using both operating and non-operating activity (Brooks and Mukherjee, 2013).
  • Balance sheet: It is considered as one of the reliable structured in respect to the total assets of an entity which is equal to the sum of debt and equity associated with the company. Financial position used to assist users of financial reports to assess overall health of an entity can be analysing effectively.
  • Cash flow statement: This financial information consists of every cash inflows of a company that receive out of their ongoing operations and outside investment sources. This information would be collected from various activity such as investing, operating and financing.

Comment on advantage and disadvantage of investment appraisal method

NPV:

  • Advantage: It take into account the time value of money so that chances of getting accurate results is more. It will assist profitability of project through using cash flows relatively than profits.
  • Disadvantage: Most of the time it failed to considered timings of cash flow. It can be difficult to determine reliable cost of capital.

IRR:

  • Advantage: It is simple to determine because it is expressed in terms of percentage. This can take into account the time value of money (Aubert and Grudnitski, 2011).
  • Disadvantage: In case of public limited company they need to considered certain regulatory needs and attain proper standards of corporate financing.

Payback period:

  • Advantage: It is one of the easy of simple method to calculate the recovery period. It is mainly used to provide estimation of future cash flows of a business.
  • Disadvantage: It ignores all the facts that few projects with long duration have huge level of return (Investment Appraisal, 2018).

Most repeatedly used appraisal method used in industry

The payback period method of investment appraisal is being subject of considerable comment and criticism in the literature. Many of the research would have surveys that have reported valuable amount of increase is used of discounted cash flow financial methods. Payback period has been shown to be one of the traditional, primary and significant method in both UK and other parts of the country. This used to provide positive aspects to capital budget size. Likewise, the importance of payback period would be seen as inversely associated to mentioned budget structure. The payback period investment appraisal as mainly used in the industry. It acts as a supportive role to sophisticated discounted cash flow method (Frank Lefley, 2018).

PART B

Calculation of various ratios

Liquidity ratios

Formulas

2017

2016

Current ratio

Current assets / Current liability

1.14232

1.24483

Liquid ratio

Current assets - (Stock) / Current liability

0.90479

0.98549

Working capital ratios

Working capital

Current assets - current liability

71.3

102.9

Working capital turnover ratios

Cost of sales / Average WC

20.7377

12.6725

Comment on the ratios

Liquidity ratio: It is mainly used to measure the overall company’s ability to pay all liability and their margin of safety by doing calculation of metrics. It is comprising of certain types. Some of them are mentioned underneath;

  • Current ratio: It is one of the important ratios that measure overall ability to make payment of short-term and long term debt obligations. The ideal ratio of to measure the performance is 2:1 (Moutinho, 2011).
  • Quick ratio: The seems to be effective measure that used to provide performance of the company in order to meet their short-term financial debt. It is calculated through dividing all current assets through total current debt. It consists of cash, marketable securities and other receivables.

Working capital ratio: It is more similar as current ratios. It is more effective consider by the accountant in order to determine total current assets and liability kept by the company with them. The liquidity ratio that analyses the firm’s ability to make payment of their current liability with total assets of the company. It is categorised into two types. Those are mentioned underneath:

  • Gross working capital
  • Net working capital.

Interpretation:

As per the above mentioned two ratios such as liquidity and working capital ratios, it has been found that current ratios of the is about 1.14 and 1.24 respectively in those two years. It is not ideal for the effective decision making because it is below 2:1. While liquid ratios are 0.9 and 0.98 which is more ideal for future capital investment. The overall results are providing valuable results to the company in terms of liquidity position.

Working capital ratios of the construction company is 20.7 and 12.67 respectively in the two year. it means the company is having efficient position in terms of total assets. It is relatively strong as compare to the last year. It is same as the current ratio is similar as current ratios. It is relatively deal in proportion to entity’s current assets to their current debt obligations.

More to read:

Cash operating cycle and their significance

The operating cycle is one of the average period of time that need for a business to make initial outlay of cash to produce goods and receive cash from customers. It is overall length of time among firm’s total purchase of stock and receipts of cash from accounts receivable. It is the time needed for a business to turn purchase into cash payment made by the customers.

Significance of operating cycle:

  • By the help of this overall financial position and health of the company can easily be determine in effective manner.
  • The cash operating risk is associated with growth through measuring the length that a company will be deprived of total cash if it enhanced their overall investments.
  • It would be helpful for the investors that wish to draw overall comparison among close competitors those are having low cash conversation period (Allen, Hemming and Potter, 2013).
  • It gauges overall effectiveness of a company’s total investment and consequently the financial position that is carried by an organisation.

Total duration of using operating cycle of a company:

The overall operating cycle of an organisation need to be pre-planned so the future investments can be made in effective manner. The main motive of the company is to earn maximum profit by proper utilisation of resources. Operating cycles can also last for varying individual such as retailer.

Operating Cycle = Inventory Period + Accounts Receivable Period

Where stock period is the value of stock time that sits in overall warehouse and accounts receivable period that takes to collect total cash from sales of stocks. The operating cycle is more often confused with all net operating period that are generated during the time.

  • The operating cycle: The total time among purchase of inventory and cash collected from total sale of inventory by the company during an accounting period of time.
  • The net operating cycle: The overall length of time among paying for stock and their cash gathered from the sale of stock.

Cash flow problems

In every business organisation, it has been found that they are facing cash related issues. Because of which they would not being able to make future planning in effective manner. In case of small businesses, the most significant aspects of cash flow administration are avoided in extended cash problems. Most of business firms that is having cash flow issues that are arises because of their financial statements (Hart and Spero, 2013). Even an organisation that makes gain can have negative cash impacts because of having lag time shipping out products. There are various ways a company can flow can be managed effectively. some of them are:

  • Keep a cash flow estimation: It is important for the company to make regular forecast of their cash inflows. It will assist them to make proper planning in respect to attain future growth for the company.
  • Access credit: accountant of credit that offers ongoing access to present capital to assist them to operate their business in effective manner. In accordance to improve the cash flow the internal funds can be increase by the company.

From the above calculated liquidity ratio which is good examples to determine, whether a company is having any cash flow related issues. As it has been found that they would having appropriate liquidity position which assist them to make future expansion of planning in right manner. In case they are not being able to make payment of all their short term debt obligation. It means that they are lacking behind some sort of cash flow issues.

Overtrading

It refers to be excessive purchase and selling of inventory through either a broker or any other investors. It is mainly occurring in case company used to expand their own operations in faster manner. This would have made directly related with liquidity issues and sometime run out of working capital limits. There is certain situation in which chances of overtrading can be arises. Growth is attaining through making important capital investment in manufacturing or operations ability before earning is determined. As per the mentioned financial statements, it has been found that they are getting sufficient amount of cash and working capital. It means that the chances of overtrading cannot be arises among them. While their liquidity position is also too good as quick ratios is close to ideal ratio of 1:1. The company A is neither being in a situation of going towards overtrading (Ehrmann, Fratzscher and Rigobon, 2011).

CONCLUSION

From the above project report, it has been concluded that International financial management is one of the important process used to analyse various accounting decision made by the companies. In order to evaluate their projects manager need to use different types of investment appraisal methods. While various ratios such as liquidity and working capital ratios is taken into account for the purpose of examine current position of the company. Use of operating cycle and their benefits is also valuable for the accountant in analysis of financial records. All the evaluation is being done to attain more reliable outcomes in near future time.

REFERENCES

Books and Journal:

Allen, R., Hemming, R. and Potter, B. eds., 2013. The international handbook of public financial management. Springer.

Aubert, F. and Grudnitski, G., 2011. The impact and importance of mandatory adoption of International Financial Reporting Standards in Europe. Journal of International Financial Management & Accounting. 22(1). pp.1-26.

Brigham, E.F. and Houston, J.F., 2012. Fundamentals of financial management. Cengage Learning.

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