May 2020

Investment appraisal

No PIN: optional lecture

cost 2200000 2600000
disposal 300000

Year Project Beta

£ £
1 1,000,000 300,000
2 1,000,000 500,000
3 800,000 900,000
4 200,000 1,200,000
5 1,200,000
5
depreciation 2,200,000 2,300,000
300,000

260,000 – 300,000 = 2,300,000

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ARR cost 2200000 2600
  A B disposal 300
Cash flows 3,000,000 4,100,000
Year Project Beta
Depreciation 2,200,000 2,300,000
£ £
total 800,000 1,800,000 1 1,000,000 300,000
Years 4 5 2 1,000,000 500,000
Average annual 3 800,000 900,000
Profit 200,000 360,000
4 200,000 1,200,000
Capital invested at 5 1,200,000
start 2,200,000 2,600,000 5
Capital invested at 0 300,000 depreciation 2,200,000 2,300,000
end (disposal)
Average capital
invested 1,100,000 1,450,000

ARR % 18%
No PIN: optional lecture 25%

ARR = average annual profit/average capital invested x 100

Payback
Project A
£m cumulative
0 -2,200,000 -2,200,000
1 1,000,000 -1,200,000
2 1,000,000 -200,000 2 + 2/8
years
3 800,000 600,000
4 200,000 800,000

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 Project B
£m cumulative
0 -2,600,000 -2,600,000
1 300,000 -2,300,000
2 500,000 -1,800,000
3 900,000 -900,000
4 1,200,000 300,000 3 + 9/12 years 3.75
5 1,500,000 1,800,000

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NPV
Project A

£m disc. Factor disc. Flows

0 -2,200,000 1.000 -2,200,000

1 1,000,000 0.870 869,565
2 1,000,000 0.756 756,144
3 800,000 0.658 526,013
4 200,000 0.572 114,351
5

The NPV of Project A £66,073

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 Project B

disc. Factor disc. Flows

0 -2,600,000 1.000 -2,600,000

1 300,000 0.870 260,870
2 500,000 0.756 378,072
3 900,000 0.658 591,765
4 1,200,000 0.572 686,104
5 1,500,000 0.497 745,765

The NPV of Project B £62,575

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IRR Project A
Discount factor of
16%
NPV @ 15% £66,073
£m disc. Factor disc. Flows

0-2,200,000 1 -2,200,000 NPV @ 16% £28,216

1 1,000,000 0.862 862,069
2 1,000,000 0.743 743,163
3 800,000 0.641 512,526 L = lower discount rate
4 200,000 0.552 110,458 H = higher
5
NPV £28,216

IRR = L + [NPVL/(NPVL-NPVH)] x (difference in discount rates)

IRR = 15 + [66073/(66073-28216)] x (16-15) = 16.75%
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IRR Project B
Discount factor of 16%
NPV @ 15% £62,575
£m disc. Factor disc. Flows
NPV @ 16% -£16,287
0 -2,600,000 1 -2,600,000
1 300,000 0.862 258,621
2 500,000 0.743 371,581
3 900,000 0.641 576,592
4 1,200,000 0.552 662,749
5 1,500,000 0.476 714,170

-£16,287

IRR = 15 + [62575/(62575-(-16287))] x (16-15) = 15.79%

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