# Capital investment appraisal Assignment Paper

Capital investment appraisal

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Capital investment appraisal is an important tool of planning process that help to make decisions on what to invest in based on their returns and initial capital of investment (Harris et al., 2011). For example, capital budgeting in SME’s helps a company to decide future investments such as entry into new markets, expansion of business activities and also the inclusion of new activities. Examples include; Accounting Rate of Return (ARR), Net Present Value (NPV), Internal Rate of Return (IRR) and Payback Period (Davies & Crawford, 2011).

 Project 1 Project 2 ARR 33% 18.7% NPV (£’ 000) 15 210 IRR 25% 53% Payback Period (yrs) 0.556 3.2

Workings

ARR for project two

Annual Depreciation = (Initial Investment – Scrap Value) / Useful Life in Years

Annual Depreciation = (£1616000 – £301,000) /15% =£197,250

Average Accounting Income = £500,000 – £197,250 = £302,750

Accounting Rate of Return =302,750/1,616,000 = 0.187 =18.7%

Where

Co = -Initial Investment =556,000

C = Cash Flow = 200,000

r = Depreciation rate = 15%

T = Time = 5yrs

= -556000+570994

=14,994

Therefore, NPV is 14, 994

14,994 = -556,000 + (500,000)/(1+IRR) + (500000)/ (1+IRR2)+(5200000)/(1+IRR3)+ (200000)/(1+IRR4)+ (200000)/(1+IRR5)

14994 = -1616000 + (500000)( 1+IRR+1+IRR2 +1+IRR3 +1+IRR4 1+IRR5)

14994= -1616000 + (500000) + (5/1+IRR)

14994+1616000 = (500000) + (5/1+IRR)

1630994= 2500000/1+IRR

1630994(1+IRR) = 2500000

1630994+1630994IRR =2500000

16309941IRR = 2500000-1630994

1630994IRR = 869006=869006/16309941

IRR= 0.532= 53%

Payback Period for project One

Payback Period = Initial Investment/ Cash Inflow per Period

= 0.556

References

Harris, E. P., & El-Massri, M. (2011). Capital Investment Appraisal. Review of Management Accounting Research, 343.

Davies, T., & Crawford, I. (2011). Business accounting and finance. Pearson.

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