Part 6

Investment Appraisal
These power points have been prepared based
on the book ‘VALUATION AND INVESTMENT
APPRAISAL’ Edited by CLIVE DARLOW and contains
quotes from the book. When studying these
materials, students are reminded the need to
respect intellectual property rights.
 Investment Steps
1. Screening
2. Evaluation (Investment Appraisal)
3. Implementation
4. Monitoring and Review
5. Auditing
 Property Values

“It is the differences in opinion concerning the

value of an asset that causes trade to take
place” (Real Estate Investment – Brown & Matysiak)
 Property Values (cont’d)
• Open Market Value
• Current Use Value
• Redevelopment Value
• Insurance Value
• Marriage Value
• Going Concern Value
 Common Methods of Investment
Appraisal
Pay-Back: Accept a project if the pay-back period is
less then an agreed cut-off period.

Pros: Easy to use.

Some company having cash flow problems
may prefer very short pay-back periods.

Cons: Pay-back period arbitrary.

 Common Methods of Investment
Appraisal (cont’d)
Discounted Pay-Back
Same as Pay-Back but taking into account the
time value of money.

Return on Investment
Accept an investment if the return on
investment is greater than an agreed target
return.
 Common Methods of Investment
Appraisal (cont’d)
The Internal Rate of Return (IRR)
Accept an investment if the internal rate of return
exceeds the opportunity cost of capital.

Net Present Value (NPV)

Accept an investment if the net present value is greater
than zero when discounted at the rate reflecting the
opportunity cost of capital.
NPV provides an unambiguous measure of profitability in
absolute terms.
(Real Estate Investment – Brown & Matysiak)
 Example

A useful example for investment appraisal can

be found in the book “ Valuation and Investment
Appraisal” (Edited by Clive Darlow). Page 307 - 310
 Example (cont’d)
Investment A – A 25-year mortgage, new industrial premises, well
secured at 50% of market value
at an interest rate of 13% pa.
Capital Outlay 1,000,000.

Investment B – Freehold Interest in new industrial

premises recently let on
25-year FRI lease with five-yearly
rent reviews. Initial Yield 7%.
Estimated Rental Growth 8% pa.
No rental growth for the 1st year.
Could be sold at the end of the lease
at 10% yield. (property becomes old).
Capital Outlay 1,000,000.
 Example (cont’d)
Investment A Investment B

IRR 13% 12.92%

NPV at 13% 0 (10,000)
NPV at 12% 78,000 118,000
Level of Risk Low High
 Example (cont’d)
Sensitivity Analysis:-
Annual Growth 25 years Investment A Investment B
(1st year = 0) IRR IRR
6% 13% 11.31%
7% 13% 12.11%
8% 13% 12.92%
9% 13% 13.77%
10% 13% 14.59%
 Example (cont’d)
Analysis:
Investment A Investment B
Initial Income 130,000 70,000
IRR 13% 12.92%
If cost of capital = Worth pursuing Worth pursuing
12%
Discount rate 12% NPV=78,000 NVP=118,000
Income growth NIL Depends on future
rental growth
Level of Risk Lower Higher
 Example (cont’d)
Final decision depends on the investor’s view of
risk and his feelings about rental growth.

It also depends on the items of investment in

the existing portfolio. Investment B may act as a
hedge against possible future levels of inflation.