ASSIGNMENT

ASSIGNMENT

ASSIGNMENT

Introduction

In this chapter we discuss various methods of evaluating investment projects. These methods are, in the main, concerned with quantitative aspects but first you need to be clear that methods of evaluation are by no means the only factors to be taken into account in investment appraisal (Farragher, 1999, 137). Thus, we might define investment appraisal as being concerned with maximising shareholder wealth, but we must be careful to qualify this concept by making it subject to constraints associated with issues of social responsibility, such as effective controls over pollution. So shareholders' wealth in this context needs to be linked with the wider view of stakeholder theory, whereby many other interested parties apart from shareholders - for example, suppliers, lenders, employees, managers, as well as the general public - need to be taken into account in assessing a project's viability. Incidentally, in the case of 'not for- profit' entities, we should follow a similar path, but substituting maximising benefits in place of shareholders' wealth.

We must also be clear that maximising wealth is not the same thing as maximising profit from a project, by minimising costs regardless of the wider implications of so doing. Shareholders will best be served by action being taken to ensure that a project will meet an economic want while maintaining a good and respected image of the entity, and indeed projects which damage that image can negate the benefits of otherwise effective marketing and promotional activities.

Capital Budgeting Techniques

Capital budgeting, which can be described as the formulation and financing of long-term plans for investment, is one of the most important responsibilities of the owners/managers of small manufacturing firms. The decisions made during the capital budgeting process determine the future growth and productivity of the firm (Almeida, 2004, 1777).

Capital budgeting is a process designed to achieve the greatest profitability and cost effectiveness in the private and public sectors of the economy. Capital budgeting and the estimation of the cost of capital (the rate of return that a firm must earn on its investments to ensure that the minimum requirements of the providers of capital are met) are the most important financial decisions facing owners/managers of the small firms (Brink, 2003, 14). The need for relevant information and analysis of capital budgeting alternatives has inspired the evolution of a series of methods to assist firms in making the “best” allocation of resources. Amongst the earliest methods available were the non-discounted cash flow methods and the discounted cash flow techniques. The non-discounted cash flow methods are form of capital budgeting techniques used in evaluating the uncertainty and risk of the value of a firm without considering the time value of money. These techniques are biased in selecting projects and also do not consider cash flows in investment decisions. The techniques constitute the traditional payback period (PB) and the accounting rate of return (ARR) techniques as thus discussed (Chartered Institute of Management Accountants [CIMA], 2002, 45).

Traditional payback period (PB)

CIMA (2002) defines payback as 'the time ...