Capital Investment Appraisal

Accounts Assignment

1)

When a firm or company decide to invest in a long term project or obtain a fixed asset; capital investment appraisal (CIA) is used in deciding which development to pursue or if any of the proposals are worth investing in. The main aim is obviously financial however this is not always the case in certain instances an organisation may undertake a task as it gives a positive image towards that administration. Initially when receiving an offer the budget of the investor needs to be taken into account, also whether this goes against the direction the corporation is heading in. Overturning a Capital investment appraisal decision is expensive, furthermore CIAs usually entail enormous amounts of money and time therefore you need to be sure it is the right decision when investing in a program, obviously you can never be 100% sure especially in the current financial climate however as sure as one can be.

Types of Capital Investment Appraisal

I will concentrate on the four main methods of capital investment appraisal which are listed in the table below also if they are discounted cash flow or non discounted cash flow which I will explain.

Type of CIA Discounted cash flow (DCF) or non Discounted cash flow (Non-DCF)

Accounting rate of return (ARR) Non-DCF

Payback period (PBP) Non-DCF

Net present value (NPV) DCF

Internal rate of return (IRR) DCF

TIME VALUE OF MONEY AND DISCOUNTED CASH FLOW (DCF)

Before understanding discounted cash flow it is imperative to comprehend the time value of money. 100 pound today does not have the same value as 100 pound in a year’s time; £100 pound received now has the chance to gain compounded interest, which brings more meaning to the common phrase “time is money”. This where discounted cash flow comes in; the future cash flows should be discounted to the present value using the discount rate, which is the direct opposite of compounding. In order for present and future values to be compared cash is considered...