FINANCIAL APPRAISAL

Alpha Consultancy Company

Alpha Consultancy Company

Introduction

Investment Appraisal

Investment appraisals definitely add value to the firm. Since, these involve various techniques which can be implemented to know the attractiveness of the particular investment. The methods include IRR, NPV, payback method etc. Investment appraisals are one of the integral parts of capital budgeting techniques (Clayman et. al., 2012; Pogue, 2011). Moreover, these techniques help the business entity to quantify the returns even in the areas such as training, marketing, and personnel etc.

Therefore, I agree that the investment appraisals do add value to the business entity. Since, every business wants to aim at the profit addition. So, it is not a good idea to underestimate the investment appraisals techniques. Every manager of the firm is posed with the various investment opportunities. So, in order to make sensible judgments for a particular investment whether for long term or short term; these techniques help the managers to quantify the particular investment. Following are the main discounted cash flow techniques available to management for investment decisions:

Internal rate of return (IRR)

Modified internal rate of return

Net Present Value (NPV)

Multi-period capital rationing

There are various quantitative and qualitative factors associated while selecting the particular project. For instance, project A might have a better IRR while the other project may have better NPV. Therefore, above mentioned are the main robust methods used for investment appraisals.

Internal rate of return

It is one of the important tools which are being used for investment appraisal purpose, LBO analysis and private equity deals etc. Simply it measures the return generated by an asset assuming that the reinvestment rate of cash flows thus generated, is the same as the IRR itself. By analyzing further it is clear that in IRR, the investment rate and the IRR itself are same. Moreover, if an analysis is done correctly, internal rate of return will be equal to the compounded annual growth (Basley & Brigham, 2011). This is clearly illustrated in the chart figure below.

Modified internal rate of return (MIRR)

As discussed earlier the biggest problem with the IRR is that it equals the RRI cash flows with that of IRR itself. However, it loses the practicality in the real world, i.e. it is not possible for the companies to achieve the similar IRR as before. Discussing the example mentioned above, the investment cash flow is different each year. Similarly, each project have different rate of return, whereas IRR ignores this point of difference. Hence, the more sophisticated technique which can takeover IRR is MIRR. Modified IRR gives managers an opportunity select the particular investment with more realistic approach. This means that the cost of capital is considered with respect to the safe assumption. Modified internal rate of return delinks the Reinvestment Rate from IRR thereby giving the manager an option to choose a different/more realistic rate (mostly Cost of Capital) thereby giving a more reliable conclusion. This is clearly illustrated in the example below:

Though, it is better choice than IRR; however both the above mentioned techniques (IRR & MIRR) do not ...