QUESTION ONE

Capital investment appraisal, also known as capital budgeting is primarily a planning

process which facilitates the determination of the concerned firm's investments, both
long term and short term. The components of the firm that come under this kind of
capital investment appraisal include property, equipment, R & D projects,
advertising campaigns, new plants, new machinery etc. Thus in simple words,
capital investment appraisal is the budgeting of major capital and investment to
company expenditure. For example, capital investment appraisal in small companies
decides on future ventures into newer markets as well as expansion and inclusion of
new activities.
The capital investment appraisal techniques used to measure capital investment
appraisal of a business project include:
Net Present Value (NPV) this capital investment appraisal technique measures the
cash in-flow, whether excess or shortfall, after the routine finance commitments are
met with. All capital investment appraisals have a single objective drive towards a
positive NPV. The NPV is a mathematical calculation involving net cash flow at a
particular present time 't' at discount rate at the same time, i.e. (t initial capital
outlay). Thus there is an inverse proportional relation between discount rate and
NPV. A high discount rate would reduce the net present value of capital. A high
interest rate increases discount rates over a period of time and most capital
investment appraisals are wary of such an increase.
Accounting Rate of Return (ARR) this capital investment appraisal technique
compares the profit that can be earned by the concerned project to the amount of
initial investment capital that would be required for the project.

Internal Rate of Return (IRR) capital investment appraisal techniques define IRR
as discount rate that gives a value of zero to NPV or net present value. Among all
capital investment appraisal techniques, IRR is generally considered to measure the
efficiency of the capital investment. Thus, if cost of capital investment in company
works out to be greater than the IRR value, the project is highly likely to be rejected.
On the other hand, a low cost of capital has more chances of being accepted. IRR is
calculated by equating NPV to zero and then deriving the discount rate. Even though
IRR and NPV are related capital investment appraisal techniques they are different
from each other. IRR considers the time value of money over the project life time
and derives the world discount rate.
Discounted Payback Period capital investment appraisals using discounted
payback period is similar to payback period but here, the time value of money or
discounted value of cash flow is considered for calculation of payback period.
All the above mentioned capital investment appraisal techniques are used for ranking
projects. Usually, organizations have many projects that are appraised
simultaneously for financial viability. Once the preliminary appraisal of a project is
completed, it is compared and ranked against other peer projects. The projects in
consideration are ranked from having high Profitability index to lowest Profitability
index. The higher ranking projects are usually implemented after careful and detailed
due diligence.

Example and application in a Cameroon company

PROJECTED CASH INFLOW AND OUT FLOW for NEWTECH

YEAR

CASH INFLOW

CASH

NET

FCFA

OUTFLOW

CASHFLOW

FCFA

FCFA

213,000,000

104,112,334

108,887,666

213,000,000

104,112,334

108,887,666

213,000,000

95,112,334

117,887,666

213,000,000

98,322,000

114,678,000

Adopting professional project or investment appraisal techniques into our analyses,

to verify the feasibility of the project initiated by NEWTECT Company, we made
use of the discounted payback period and the net present value techniques. These
techniques are considered because they take into consideration the time value of
money in their analyses. The net present value technique is used because it takes
care of the wealth maximisation objective of the shareholder.

NET PRESENT VALUE TECHNIQUE

YEAR

NET

Discounting

PRESENT

CASHFLOW

factor

VALUE=(NET

FCFA

1/(1+ 0.195)

CASHFLOW)
n

(1/(1+0.195) )
FCFA
0

(130,000,000)

1.000

(130,000,000)

108,887,666

0.837

91,138,976

108,887,666

0.700

76,221,366

117,887,666

0.586

69,082,172

114,678,000

0.490

56,192,220

NET PRESENT VALUE

162,634,734

The net present value is positive that is 162,634,734FCFA implying that the project
maximises shareholders wealth hence feasible using the NPV technique to make an
appraisal. This is because a project with a positive net present value maximises the
wealth of its shareholders over it lifetime. Thus, NEWTECT Company, is advised
to undertake the investment.
DISCOUNTED PAYBACK TECHNIQUE
YEAR NET

Discounting

DISCOUNTED

Cumulative

CASHFLOW

factor

NET CASHFLOW

DISCOUNTED

FCFA

1/(1+

(NET CASHFLOW)

NET

0.1956)

1/(1+ 0.1956) FCFA

CASHFLOW
FCFA

(130,000,000) 1.000

(130,000,000)

(130,000,000)

108,887,666

0.837

91,138,976

( 38,861,024)

108,887,666

0.700

76,221,366

37,360,342

117,887,666

0.586

69,082,172

106,442,514

114,678,000

0.490

56,192,220

162,634,734

Discounted payback period = A + B/C where;

A= the year with the last negative cumulative discounted cash flow
B= the absolute value of the last negative cumulative discounted cash flow
C= the discounted cash flow for the year immediately after the year with the last
negative cumulative discounted cash flow
From the table above, the discounted payback period is = 1 +

38,861,024
76,221,366

= 1 year and 6months

Thus, Payback period = 1 year and 6months
The analyses above show that the discounted payback period for our project is 1.5
years which is less than the 2 years that was previewed for the company to pay off
her debts and start maximising shareholders wealth. Thus, the project is feasible and
we highly advised NEWTECT Company, to carry out the project.
Investment decisions are at the heart of the management of all businesses. Errors in
these decisions can, and do, prove fatal for many businesses. Since the higher the
interest rate, the lower the net present value, our analyses were done at 1.5% per
month. From the initiation to the appraisal of the project, it is clear that the
investment will maximise shareholders wealth. All the investment appraisal
techniques employed here showed that investment is feasible