Please enable JavaScript.
Coggle requires JavaScript to display documents.
Project Appraisal - Coggle Diagram
Project Appraisal
Project appraisal techniques
Project appraisal methodologies are used to assess a proposed projects potential success
These methods evaluate a projects viability considering factors such as available funds and the economic climate
A good project will service debt and maximise shareholder wealth
Companies normally undertake investment appraisal before committing to capital investment
Appraisal of capital projects typically involves the estimation of future costs and benefits over the project life, particuarly the forecasting of revenues, costs and savings
Forecasting should be as reliable as possible
The assumptions on which the forecasts are based should be clearly stated so they can be assessed and approved by the senior management working on behalf of the shareholders
There should also be an assessment of expected returns compared with the expenditure or investments made
The initial capital cost of a project could include any of the fllowing
The purchase cost of a non-current asset
Realisable value of listing assets to be used in the project
Investment in additional working capital
Capitalised research and development expenditure
Investment in capital expenditure is usually made with the intention of generating returns by increasing sales revenue or making savings in operating costs over the life of the assets, at the end of the asset's useful life, some assets such as computer equipment or machinery might be sold for scrap or in a second hand market for their residual value
There are two basic approaches to project appraisal
Discounted
Discounted cash flow methods based on the time value of money are more sophisticated
Net present value
Internal rate of return
Discounted payback
Non-discounted cash flow
Payback method
Accounting rate of return
Factors affecting project appraisal
The most common investment appraisal objective is to maximise shareholder value, this is linked to
Cash
Cash flow is more closely linked to shareholder wealth than profit
Return on the cost of capital
A company or a project is in profit when the returns from the investment exceed the cost of capital
Long term value
The stock market places a value on the company's future potential not just its current profit levels
Future cash flows are more relevant than accounting profits in capital investment appraisal because
Profits are subjective and can't be spent
Cash is required to pay dividend
Long term cash flow forecasting of revenues, savings and costs is an essential part of project appraisal
Relevant factors vs non relevant factors
Relevant factors
Relevant factors are those vital for making investment decisions based on future net incremental cash flows
These include
Future costs
An estimated quantification of the amount of a prospective expenditure
Incremental costs
Additional costs incurred from undertaking an additional activity or increasing the level of production
Cash flows or cash based costs
Any expenses or costs that are predicted to be paid in cash
Financing costs
Opportunity cost
Timing of returns
Early returns are preferred to later ones
Returns can be reinvested ti generate a higher value at the later date
Working capital
New project require additional working capital such as inventory and trade receivables in running the project which must be taken into consideration
Taxation
The profits subject to taxation and tax relief from the capital cost of the project must be considered
Future inflation
Future revenues and costs will be impacted by inflation to different degrees
Non relevant
Non-relevant factors are those that are irrelevant for project appraisal decision making
They include
Sunk costs
Past expenditure that cannot be recovered and hence cannot be influenced by the current decision
Committed costs
Obligations tha cannot be revoked
Non-cash items
Items such as depreciation which are just accounting entries with no impact on cash flows
Allocated costs
Costs that are clearly assigned to specific projects, processes or departments such as the apportionment of overheads that would be incurred in any event
Identification and analysis of projects
A project can be defined as a work plan that is carefully designed to achieve a specific objective, within a specified time limit, while consuming a planned amount of resources
Costs benefits and risks
The costs and benefits of a propsoed capital project should be estimated and evaluated over its expected useful life along with any risks from the projects.
Investment appraisal assessess
Costs and benefited over the projects life
The level of expected returns from the project or invested expenditure
The risks involved, including uncertainty about the timing and volume of returns
Costs are likely to include expenditure on a non current asset and running costs for the asset over its expected project life, these costs could provide benefits through increased sales revenue or through savings in operating costs
The asset might have a residual value at the end of its useful life
When analysis a project, the following questions need to be asked to ascertain if the project is viable
What for?
The objectives of the project
How?
The process and the internal and external resource requirements
Who?
For whom, by whom
When?
The time factor
Where?
The location