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Presentation On Investment Appraisal Technique

Introduction of The Group


Name Nur-E-Ferdous Mohsi Nihad Mosabbir Ornab Rajesh Paul Md. Shuaib Shahriar Rusho S. M. Kaiser Ahmed Lamia Nuzhat Shashi Md. Riaz Rahman Student ID 590 613 617 620 625 1923 1929

What Is Investment?
Any act which involves the sacrifice of an

immediate and certain level of consumption in exchange for the expectation of an increase in future consumption.

Investment Appraisal Technique


Investment appraisal is a technique or a

process of determining whether investing in a project is worthwhile or not.

Why Investment Appraisal Technique?


Investment assumes that the investment will yield future income streams. Investment appraisal is all about assessing these income streams against the cost of the investment.

Types Of Investment Appraisal Technique


Investment Appraisal Technique

Traditional Approach

Modern Approach

Payback Period

Discounted Payback Period

NPV

IRR

PI

Traditional Approach
Payback Period

Discounted Payback Period

Payback Period Method


The length of time required for an Investments

net revenues to recover its initial investment cost.

The project which can recover its initial

investment within the shortest possible time should be accepted.

Payback Period Method


Formula:

Years before full recovery + Uncovered Cost at The Start of The Year Annual Cash Flows during that year

Payback Period Method


Example: Project A Year Investment O 1 2 3 Payback Period = 3 years 300000 100000 100000 100000 Cash flows

Payback Period Method


Example: Project B Year O Investment 300000 Cash flows

1
2 3

150000
120000 100000

Payback Period:2 years+ 30000 100000 =2 years 3 months 18 days

Payback Period Method


Example: Project C Year O 1 2 3 4 Investment 300000 90000 90000 90000 60000 Cash flows

Payback Period:3 years +30000 60000 =3 years 6 months

Payback Period Method


The shorter the payback ,the better it is. So

project B should be chosen.

Payback Period Method


Advantages:
Widely used method of assessing an

investment.

Easy to calculate and easy to

understand.

Helps to avoid giving too much weight to

risky, long-term projections.

Payback Period Method


Disadvantages:
Ignores the value of any cash flows once

the initial investment has been repaid.

Focuses on relatively short-term cash

flows.

Does not consider time value of money.

Discounted Payback Period Method


The length of time required for an investments

cash flows discounted at the investments cost of capital to recover its cost.

Discounted Payback Period Method


Formula:

Years before full recovery of discounted annual cash flows + Uncovered Cost at The Start of The Year Cash Flows discounted during that year

Discounted Payback Period Method


Example: The cash flow is given in the table where discount rate or interest rate is 10% Year Investment Cash flows Discounted Cash flows O 300000

1
2

150000
120000

136364
99174

3 100000 75131 Discounted Payback Period:2 years+64462 100000 =2 years 7 months 22 days

Discounted Payback Period Method


Advantages:
By considering the capital costs, it shows

the breakeven year after covering debt and equity cost.

Disadvantages:
It ignores cash flows that are paid or

received after the payback period

Modern Approach
Net Present Value

Modern Approach

Internal Rate of Return

Profitability Index

Net Present Value (NPV)


A method of ranking investment proposals

that discounts all cash flows at the projects cost of capital which are added and then the cost outlay is deducted from that total value.

The project with higher NPV should be chosen.

Net Present Value (NPV)


Formula:

NPV = present value of cash inflows less present value of cash outflows

NPV= - Co + [Cn / (1 + i)n ]


Here, Co= cash outlay Cn=total cash inflows (1 + i)n=Discount factor

Net Present Value (NPV)


Example:
The cash flow is given in the table where discount rate or interest rate is 10% Year O 1 2 3 Investment 300000 150000 120000 100000 NPV=310669-300000=10669 136364 99174 75131 Cash flows Discounted Cash flows

Net Present Value (NPV)


NPV Profile:

Net Present Value (NPV)


Advantages:
Considers the time value of money Considers all relevant cash flows, so that

it is unaffected by the accounting policies

Risk can be incorporated into decision

making by adjusting the companys discount rate

Net Present Value (NPV)


Disadvantages:
Requires the calculation of discount rate.

Only valid for discount rate.

Internal Rate of Return(IRR)


The discount rate that forces a projects NPV

to equal zero. A project is accepted if the IRR is greater than the cost of capital.

Internal Rate of Return(IRR)


Formula:

IRR = L +NPVL/(NPVL-NPVH) (H-L)


Here, L=lower cost of capital H=higher cost of capital NPVL=NPV of lower cost of capital NPVH=NPV of higher cost of capital

Internal Rate of Return(IRR)


Example:
The cash flows of a project with 10% cost of capital is given below:
Year o Investment 100000 60000 70000 50000 .909 .826 .751 54540 57820 37550 Cash flow DF Present V

NPV=49910

Internal Rate of Return (IRR)


The cash flows of a project with 20% cost of capital is given below:
Year o Investment Cash flow 100000 60000 70000 50000 .833 .694 .578 49980 48580 28935 DF Present V

NPV=27495

Internal Rate of Return (IRR)


Now IRR,(using 10% and 20% cost of capital)

IRR=10%+49910/(49910-27495)(20%10%) =32.266%

Internal Rate of Return (IRR)


IRR Acceptance:

IRR<Given Interest rate IRR>Given Interest Rate

Internal Rate of Return (IRR)


Advantages:
Helps to measure the worth of an

investment

Allows the firm to assess whether an

investment would yield a better return

Allows to comparison of projects with

different initial outlays

Internal Rate of Return (IRR)


Disadvantages:
IRR is a only a process of accepting or

rejecting the project.

IRR is sophisticated and relatively

complicated ways of evaluating a potential investment.

NPV Vs. IRR

NPV Vs. IRR


The NPV and IRR both make the accept and

reject decisions

The decision will be same for the independent

projects

If the projects are mutually exclusive then

ranking conflicts arise. NPV should be used then.

Profitability Index
It allows a comparison of the costs and

benefits of different projects to be assessed and thus allow decision making to be carried out.

Profitability Index
Formula:

Net Present Value Profitability Index = --------------------Initial Capital Cost


In case of multiple projects with positive NPVs

with limited resources, PI helps to choose the project(s) that gives the highest NPV per dollar of investment.

Profitability Index
Projects A B C D E F -Co -7 -8 -4 -10 -13 -7 PV 11 15 5 6 15 10 NPV +4 +7 +1 +4 +2 +3 PI .57 .87 .25 .40 .15 .42

Profitability Index

The higher the PI, the better it is. So, Project B should be selected as it has the highest PI 0.87. Projects in ascending order

Project B

Project A

Project F

Thank You

Any Question