Capital Investment Appraisal essay

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Investing in the current world depends on the market research an investor has done. Information in the global market count for the largest percentage of capital needed while putting up a business. The knowledge of the line of operation that you take will determine the output of the projects taken. The investor in the study whom we call businessman X should take precaution before investing the inherited money. A capital of $300,000 for a start can recoup a profit to uphold a business to a higher level. 

In the case of study, investor X has just graduated from a university with a degree in business. The training in the course “today entrepreneur” has equipped the investor with different strategies of handling challenges in the modern business environment. The two franchises are viable in the modern market. The choice of investing in a franchise duly depends on the business idea options one has. In business, the time period determine the returns got. Some projects give returns after a short duration while others will take long duration.

In the projects L and S, both have an initial outlay of 1million dollars. The project life span of the two investments is five years. This means as the investor X, will dispose of the entities when they have one year remaining. The cost of capital, which is presented by the risk of return, is the same for the two projects. Therefore, the two projects have the same environment and risks associated.

The options available for investor X are mentioned in the details and reasons for the thought of investing. Growth of the entrepreneurial spirit has led to the information on the two projects. Capital budgeting decisions are the major contributors of sound judgment in entrepreneurship. Techniques assist in ranking the returns arising from the projects. The case of study can be analyzed using various methods of investment appraisal. These methods vary in information that they need to get the results. Through the use of professional methods, the investor can get the viable project. Also, the risks and time period needed to recover the amount invested influence the choice of the project. The method used can either be traditional or the modern school of thought. The techniques for verifying the plausibility of the projects are:

  1. Payback period
  2. Accounting rate of return
  3. The net present value
  4. Profitability index
  5. Discounted payback period

The above methods have the following advantages:

  • They present the returns expected in the future
  • Future value of money is taken into account. Therefore, the inflation factor of money is taken care of
  • They also distinguish between projects that are acceptable and the rest. In the long run basis, the methods will give the reason for acceptability or rejection.
  • The method ranks the projects from the highest to the lowest in form of returns.
  • These methods can be used to verify the viability of any project.

Answer to questions

1) Payback Period

Payback period is one of the traditional methods used in the appraisal of projects. It is referred to as traditional because it does not take in the factor of time. The inflation factor is not considered in this technique. Money loses value with time. The value of a dollar today will not remain constant in the next two years.

In the analysis, the project with the shortest payback period is preferred to those which characterize a longer payback period. The reason is that the liquidity level of a short time payback period project is guaranteed. The longer the payback period, the more risks the project has. The money recouped can be reinvested to increase profitability.

Some factors act as the drawback to the argument of payback period analysis. The factor of the market prevailing interest rates affect the duration that the project repay the initial outlay.

The payback period is calculated as:

PBP =    Initial Outlay

           Annual cash inflows

For the project S, the payback period is calculated as:

Initial investment outlay = 1,000,000$

YEAR

1

2

3

4

CASH INFLOW

700,000

500,000

200,000

300,000

CUMMULATIVE REPAYMENT

700,000

300,000

 

 

The recouping takes one year and some months. By the end of the second year, the investor has received back his investment. To be specific of the months, it is calculated as follows:

                                               300,000 x 12   =7.2

                                               500,000

The two projects are viable according to the results from the tests and appraisal techniques. Project S though has an advantage from the project L. The difference is based on the payback period method. Project S is viable for implementation. As the investor has only a capital of $300,000, he can only take up one project. The investor can start with project S which starts up is fast and later take up project L. 

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