Programme 
Diploma in Business 
Unit Number and Title 
Unit 2 Managing Financial Resources and Decisions 
QFC Level 
Level 5 
Unit Code 
H/601/0548 
The financial statement of the company helps the various stakeholder of the company to provide various information in relation to the business. The stakeholder can use the various ratios analyze to interpretation the performance of the business. The investment appraisal technique helps the owner of the business to make various decisions in relation to the business.
The term investment appraisal helps in making decision regarding proposed long term capital decision.
It is an important process followed by the Midway limited to effectively and efficiently utilize the resources in the long term investments, the benefits of whose will be derived over a long span of time. There always exists an uncertainty attached to various alternatives available to the Midway limited regarding investment decision making. The investment appraisal decision helps in gathering long term fund investment decision in anticipation of expected future cash flows. It helps in putting an impact on basic character of the enterprises. The decision generally involves of outflow of funds which is irreversible (Suopajärvi, et. al., 2013). There are some features of the investment appraisal decisions which are to be kept in mind while evaluating the investment proposal
Before making a decision regarding acceptability of the proposal the profitability arise from capital expenditure alternatives should also be checked which will help us to derive whether to accept the decision or not. For the evaluation of investment related decision in the proposed capital expenditure there are various methods available to us under the investment appraisal techniques. Any method can be used, on the basis of which selection of alternatives is determined. Sometimes there is possibility of selecting one or more alternatives in the order or priority or in the order of profitability. The importance should be given to the proposals resulting in more profit generation comparison to those alternatives where there are either no profits or fewer profits with the previous best alternative (Hosoya & Yashima, 2013). There are number of techniques or methods which may be taken into consideration while evaluating the investment appraisal decision are as follows
Investment appraisal techniques 

Traditional or non discounted cash flow techniques 
Modern or discounted cash flow techniques 
Average rate of return technique 
1. Net present value technique 
Payback period technique 
2.Profitability index technique 

3.Internal rate of return technique 

4.Modified internal rate of return 

5. Discounted payback period technique 

6. Net present value technique 
Facts of the problem: There are two proposals or investment scenario available to the Midway Limited, a manufacturing company. The company can choose either of the two available options. Both the projects involve investment in particular machinery which will cost £125,000 to the company. It is given that outflow will be made at the first day of the year and it has been further assumed that inflow will come to the company at the end of the year
First proposal that is machine 1 which will cost around £125,000 to the organization and will give returns for 3 years then the machine 1 will be disposed of at a scrap value of £25,000after that company will purchase a new machinery for £ 60,000 which will further give return to the company for next five years.
Second proposal involves purchase of machine 2 which will also cost £125,000 to the company and will give returns or inflows for 6 years. In this case there will be no scrap or residual value at the end of 6^{th} year.
Further it is given in the problem that Midway Limited uses straight line method of depreciation and the cost of infusing capital in the organization is 20%
Solution to the problem: Payback period method is most important, popular and widely used method to calculate the investment appraisal technique. It is number of years it takes a firm to recover its original investment from net cash flows. It is calculated by dividing the after tax cash inflows relating to the results or performance of investments made over a span of time. As in our case of Midway limited in both the available proposals the yearly returns or cash flows are unequal payback period is calculated by adding up the cash inflow until the total is equal to initial cash outlay (Huerta & Gair, 2011).
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PROJECT A payback period 
amount in £ 000's 


year 

2016 
2017 
2018 
2019 
2020 
2021 
cash flow 
125 
60 
60 
60 
50 
50 
40 
Depreciation 

33.33 
33.33 
33.33 
12 
12 
12 
Residual value purchase of new machinery 



35 



cash flow before depreciation 
125 
93 
93 
58 
62 
62 
52 
cumulative cash flow 
32 
62 

1 year 
4.1290323 
months 

(Elmassri, et. al., 2016)
PROJECT B payback period 
amount in £ 000's 

year 

2016 
2017 
2018 
2019 
2020 
2021 
cash flow 
125 
20 
30 
40 
70 
80 
65 
Depreciation 

20.833 
20.833 
20.833 
20.833 
20.833 
20.833 
Residual value 







cash flow before depreciation 
125 
41 
51 
61 
91 
101 
86 
cummulative cash flow 
84 
33 

2 years 
6.4918033 
months 

Net present value method: Net present value method or NPV method is a discounted cash flow analysis technique in which inflow received in future over the span of time are discounted at the rate of cost of capital that would cost to the Midway limited. In our case cost of capital is 20%. The present value of the total returns or inflows than compared with the initial outlay or present value of outflow invested over the period of time (Locatelli, et. al., 2016).
Formulae of Net present Value (NPV) = present value of cash inflow – present value of cash outflow
Calculation of depreciation 

Project A 

33333.333 
(12500025000)/3 



12000 
60000/5 




Project B 

20833.333 
125000/6 

PROJECT A NPV 

amount in £ 000's 




2016 
2017 
2018 
2019 
2020 
2021 
total 









cash flow 
125 
60 
60 
60 
50 
50 
40 

Depreciation 

33.33 
33.33 
33.33 
12 
12 
12 

Residual value purchase of new machinery 



35 




Net profit before depreciation 

93 
93 
58 
62 
62 
52 

Discount rate 
1 
0.8333333 
0.6944444 
0.5787037 
0.4822531 
0.4018776 
0.334898 

discounted cash flows after tax before depreciation 
125 
77.775 
64.8125 
33.755787 
29.899691 
24.916409 
17.414695 
123.5741 
PROJECT B NPV 

amount in £ 000's 




2016 
2017 
2018 
2019 
2020 
2021 
total 









cash flow 
125 
20 
30 
40 
70 
80 
65 

Depreciation 

20.833 
20.833 
20.833 
20.833 
20.833 
20.833 

Residual value 








Net profit before depreciation 

41 
51 
61 
91 
101 
86 

Discount rate 
1 
0.8333333 
0.6944444 
0.5787037 
0.4822531 
0.4018776 
0.334898 

discounted cash flows after tax before depreciation 
125 
34.0275 
35.300694 
35.204282 
43.804495 
40.522521 
28.745298 
92.60479 
Accounting rate of return ARR helps to create the ratio analysis by comparing average income to the investment made in the project ARR= average income of the firm / Average capital outflows This is one of the non discounted cash flow technique which helps to calculate estimate of net annual income which is not based on net annual cash inflows. It helps in choosing the project between two or more mutually exclusive projects such the project with more ARR can be chosen. It do not consider time value of money.

Average rate of return (ARR) 

PROJECT A 

Average Profit 
53 

Average Investment 
80 

ARR 

67% 
PROJECT B 

Average Profit 
51 

Average Investment 
62.5 

ARR 

81% 
Comparison analysis amount in £ 000's

Project A 
Project B 
NPV Basis 
The NPV of project A is 123.5741 which is 30.96 more than what Midway limited is receiving from project 2. 
The NPV of project B is 92.60479 which is 30.96 less than what Midway limited is receiving from project 1. 
Payback period basis 
The payback period for the project A is 1 year and 4.2 months which is 1 year and 2.2 months less than project B 
The payback period for the project B is 2 years and 6.49 months which is 1 year and 2.2 months more than project A 
Average rate of return 
The average rate of return of project A is 67 % 
The average rate of return of project B is 81 % 
Overall conclusion 
If company is looking for long term profitability than company should go for project A and wants to receive funds in short span of time 
In no case Midway limited should opt for the project A 
(Herbener & Rapp, 2016)
Limitation of investment appraisal techniques in decision making

Limitation of using Payback 
Limitation of using NPV 
1 
More importance to liquidity rather than profitability 
Difficult to understand and use 
2 
does not consider time value of money 
Cost of capital changes with the period of time 
3 
Does not measure risks in the projects 
Miscalculations in mutually exclusive project for different project span 
4 
It is subjective decision 

(Herbener & Rapp, 2016)
There are various limitations to ratio analysis. Some of them are discussed below
So it may be concluded that the ratio analyze helps in various stakeholder to make various decision in relation to the business. The management of the business strategy can use various investment appraisal techniques to determine the feasibility of any project.
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