CAPITALINVESTMENTAPPRAISAL[MRKAYBEE]

I
NVESTMENTAPPRAI
SALi
nvol
vesas
eri
esoft
echni
ques
,whi
chenabl
esabus
ines
stof
inanc
ial
ly
appr
ais
einves
tmentpr
ojec
ts.

o I
tcanbeus
edt
ocompar
edi
ffer
entpr
ojec
tst
odet
ermi
newhi
chi
smor
efavour
abl
e.

o mai
nmet
hodsus
edt
oeval
uat
einves
tmenti
ncapi
talpr
ojec
tsar
e:

 Ac
count
ingRat
eofRet
urn.

 PayBac
kPer
iod.

 NetPr
esentVal
ue.

 I
nter
nalRat
eofRet
urn.

Account
ingRat
eofRet
urn(
ARR)

o I
samet
hodofc
api
tali
nves
tmentappr
ais
alwhi
chus
est
heac
count
ingpr
ofi
tsorear
ningsofan
i
nves
tmentovert
hel
ifeoft
hei
nves
tmentandmeas
urei
tagai
nstt
hec
ostoft
hei
nves
tmentt
oget
t
her
etur
nont
hei
nves
tment
.

o I
tisc
alc
ulat
edasf
oll
ows
:

ARR = Ave
ragePr
ofi
t x100

Ave
rageI
nve
stme
nt 1

Ave
rageI
nve
stme
nt= I
nit
ialc
ost+Sc
rapeval
ue+Addi
ti
onalWor
kingCapi
tal

Advant
agesofAccount
ingRat
eofRet
urnMet
hod(
ARR)

o I
tiss
impl
eandeas
ytoc
alc
ulat
e.

o Takesi
ntoac
countal
lthes
avi
ngsovert
heent
ireper
iodofi
nves
tment
.

o I
sbas
edonac
count
ingpr
ofi
trat
hert
hanc
ashi
nfl
ow.Ac
count
ingpr
ofi
tsc
anbeeas
ilyobt
ained
f
rom f
inanc
ials
tat
ement
s.

o Meas
urest
hebenef
iti
nper
cent
agewhi
chmakesi
teas
iert
ocompar
ewi
thot
herpr
ojec
ts.

Page1
 o Thi
smet
hodhel
pst
odi
sti
ngui
shbet
weenpr
ojec
tswher
ethet
imi
ngofs
avi
ngsi
sappr
oxi
mat
ely
t
hes
ame.

Di
sadvant
agesofAccount
ingRat
eofRet
urnMet
hod

o Notat
ruer
ateofr
etur
n;t
imeval
ueofmoneyi
signor
ed.

o Us
esanar
bit
rar
ybenc
hmar
kcut
offr
ate.

o Bas
edonac
count
ingneti
ncomeandbookval
ues
,notc
ashf
lowsandmar
ketval
ues
.

Exampl
e1

MrKaybeei
scons
ider
ingt
hepur
chas
eofamac
hinec
ost
ing$15000.Themac
hinei
sexpec
tedt
o
haveaus
efull
if
eoft
hreeyear
swi
thnos
crapeval
ue.Themac
hinewi
llear
npr
ofi
tsasf
oll
ows
:

Year Prof
its

1 $2000

2 $5000

3 $5000

Thepr
ojec
twi
llr
equi
reani
ncr
eas
einWor
kingCapi
talof$4000.

Cal
cul
atet
heAc
count
ingRat
eofRet
urn(
ARR)
.

Ans
wer

Ave
ragepr
ofi
ts = 2000+5000+5000

=$4000

Ave
rageI
nve
stme
nt = 15000+4000

=$11500

ARR = 4000×100

11500

=$34.
78%

Page2
PayBackPeri
odMet
hod(
PBP)

o I
sthet
ime(
numberofyear
s)i
ttakesf
orc
ashf
lowsofi
ncomesf
rom apar
tic
ularpr
ojec
ttoequal
t
hei
nit
iali
nves
tment
.Whenf
acedwi
thac
hoi
ce,t
hepr
ojec
twi
ths
hor
tes
tpaybac
kper
iodi
s
pr
efer
red.

o Thef
orec
astc
ashf
lowsf
oryear
sar
eaddedupunt
ilt
heys
um upt
othei
nit
ialc
api
talout
lay.

I
tisnot
edt
hatt
hismet
hodi
sbasedonCas
hfl
owsonl
yandnotpr
ofi
ts.Depr
eci
ati
oni
snott
akeni
nto
consi
der
ati
onwhi
lecal
cul
ati
ngt
hepaybackper
iod.

Exampl
e2

I
fthet
otalc
ostofPr
ojec
ts–A&Bi
s$12000eac
h.Ther
esi
dualval
ueofbot
hpr
ojec
tsaf
terf
our
year
siszer
o.

Proj
ectA Proj
ectB

Expect
edCas
hFl
ows $ $

Year1 4000 3000

2 4000 5000

3 4000 5200

4 4000 5800

Requi
red

Cal
cul
atet
hePayBac
kPer
iodf
orPr
ojec
tsAandB.

Ans
wer

PayBackPeri
odf
orProj
ectA&B

Pr
ojectA Pr
ojectB

Ye
ar AnnualCas
hfl
ow Cumul
ati
veCas
hfl
ow AnnualCas
hfl
ow Cumul
ati
veCas
hfl
ow

0 (
12000) (
12000) (
12000) (
12000)

1 4000 (
8000) 3000 (
9000)

2 4000 (
4000) 5000 (
4000)

3 4000 4000 8000 4000

4 4000 5800 9800

Page3
 Pr
oje
ctA Pr
oje
ctB

PayBac
kPe
riod = 3year
s = 2ye
ars +4000x12mont
hs

8000

=2year
s6mont
hs

I
tisrecommendedt
oinves
tinProj
ectBbecaus
eithasas
hort
erPayBackPeri
od.

From t
heabovecas
hfl
ow f
orecas
t,not
ethat
:

o Year0i
stheyeari
nwhi
cht
hei
nves
tmentwasdone.

o Thef
igur
esonbr
acket
sindi
cat
eac
ashout
flow oranegat
ivebal
anc
e.

o Thec
umul
ati
vec
ashf
low c
olumni
sshowi
ngt
het
otalac
cumul
ati
ngc
ashf
lowsbys
ubt
rac
tingt
he
t
otalCas
hfl
ow f
rom t
hei
nit
ialout
lay(
12000)
.

o I
nthi
scas
e,t
hepaybac
kper
iodi
sthet
imet
akent
orec
overt
hei
nit
ial$12000i
nbot
htwo
pr
ojec
tsA&B.

o I
npr
ojec
tA,t
hec
ashf
lowsf
orYear1,2and3gi
veat
otalof$12000c
ombi
ned.Thi
smeanswe
onl
ytake3year
stor
ecovert
hei
nit
ialc
ostof12000.Ther
efor
ethepaybac
kper
iodi
s3year
s.

o I
npr
ojec
tB,t
hec
ashf
lowsf
orYear1and2gi
veat
otalof$8000c
ombi
ned.Thi
smeanst
her
eisa
s
hor
tfal
lof$4000t
oamountt
othei
nit
ialc
api
talout
lay.Thec
ashf
low f
ort
he12mont
hsofYear
3i
s$8000.Ther
efor
e,bys
impl
epr
opor
tion,t
henumberofmont
hsr
equi
redt
orai
set
he
out
standi
ng$4000i
scal
cul
atedasf
oll
ows
:

4000×12mont
hs

8000

=6mont
hs

o Ther
efor
e,t
hepaybac
kper
iodi
s2years6mont
hs.

Advant
agesofPayBackPeri
od

o Eas
ytounder
standandc
alc
ulat
e.

o Les
sti
mec
ons
umi
ng,dec
isi
onsc
anbequi
ckl
y.

o I
tputemphas
isonl
iqui
dit
ypr
inc
ipl
eoff
irm,t
hes
hor
tert
hepaybac
kper
iod,t
he gr
eat
ert
he
pr
ojec
t'sl
iqui
dit
y,ot
hert
hingshel
dcons
tant
.

o I
ncur
slow c
osti
neval
uat
ingpr
ojec
ts.
Page4
 o Thi
smet
hodus
edc
ashf
lowsi
nst
eadofac
count
ingpr
ofi
t.

o I
tisf
rui
tfult
omeas
ureas
hor
trunper
for
manc
eofaf
irm.

Di
sadvant
agesofPayBackPeri
od

o I
gnor
est
het
imeval
ueofmoney.

o Requi
resanar
bit
rar
ycut
offpoi
nt.

o I
gnor
esc
ashf
lowsbeyondt
hec
utof
fdat
e.

o Does
n'tt
akei
ntoc
ons
ider
ati
ont
hei
nfl
ow ofc
ashaf
tert
hepaybac
kper
iod.

NetPres
entVal
ue(
NPV)

o Unl
ikeot
heri
nves
tmentappr
ais
alt
echni
ques
,theNetPr
esentVal
uec
ons
ider
sthet
imeval
ue
ofmoney.

o Bydi
scount
ingt
hef
orec
astc
ashf
lows
,thei
rval
uec
anbeexpr
ess
edi
nter
msoft
oday'
sval
ue
ofmoney.

o Thei
deaofdi
scount
ingi
sadopt
edbec
aus
e,wi
tht
oday'
smoney:

1.I
tcanbes
penti
mmedi
atel
yandt
hebenef
itsoft
hisexpendi
tur
ecanbeobt
ained
i
mmedi
atel
y.

2.Ther
eisnowai
ti
ngi
nvol
ved.The$1000c
oul
dbes
avedatt
hec
urr
entr
ateofi
nter
est
.The
t
otalofc
ashpl
usi
nter
estwi
llbegr
eat
ert
hant
heof
ferof$1000i
noneyear
’st
ime.

3.Thec
asht
odayi
scer
tai
n,butt
hef
utur
ecas
hof
feri
sal
waysopent
o unc
ert
aint
y.

o Thet
echni
quei
nvol
vest
heus
eofdi
scount
ingf
act
orsbywhi
cht
hec
ashf
lowsar
emul
ti
pli
edt
o
gett
het
imeval
ueoft
hei
nves
tment
.

o Asar
ule,anyi
nves
tmentt
hatyi
eldsapos
iti
veNetPr
esentVal
uei
swor
thvent
uri
ngi
nto,ast
he
val
uei
ndi
cat
est
henetdi
scount
edr
etur
n.

o Therearet
hreemandat
oryt
hingsrequi
redi
nordert
ocal
cul
atet
heNetPres
entVal
ue:

1.Fut
ureCas
hFl
ows

2.Di
scount
ingr
ate.

3.I
nit
ialI
nves
tmentAmount
.

o NPV=Sum (
Fut
ureCas
hFl
ows×Di
scount
ingr
ates%)–I
nit
ialI
nves
tmentCos
t.

Page5
Exampl
e3

MrKaybeei
scons
ider
ingt
opur
chas
eanew mac
hineatac
ostof$100000.Themac
hinewi
llhave
f
iveyearl
ifewi
thnor
esi
dualval
ueatt
heendoft
hatt
ime.Thees
timat
edCas
hfl
owsgener
ated
byt
hemac
hinear
egi
venbel
ow.TheCur
rentCos
tofCapi
tali
s10%.

Year Cas
hFl
ows

1 25000

2 40000

3 48000

4 52000

5 45000

Thepr
esentval
ueof$1i
sasf
oll
ows
:

10%

1 0.
909

2 0.
826

3 0.
751

4 0.
683

5 0.
621

Requi
red

Cal
cul
atet
heNetPr
esentVal
uef
ort
hemac
hine.

Ans
wer

Year Cas
hFl
ows
($) Di
scount
ingFact
or(
10%) Pres
entVal
ue(
$)

0. (
100000) 1 (
100000)

1. 25000 0.
909 22725

2. 40000 0.
826 33040

3. 48000 0.
751 36048

4. 52000 0.
683 35516

Page6
 5. 45000 0.
621 27945

NetPres
entVal
ue 55274

o TheNetPr
esentVal
uec
ant
hebeobt
ainedbyaddi
ngal
lthepr
esentval
ues(
dis
count
edc
ash
f
lows
)ands
ubt
rac
tingt
hei
nit
ialc
api
talout
lay.

Advant
agesofNetPres
entVal
ue

o I
tcons
ider
sbot
hthet
imi
ngofc
ashf
lowsandt
hes
izeoft
hem i
nar
rivi
ngatanappr
ais
al.

o Ther
ateofdi
scountc
anbevar
iedt
oal
low f
ordi
ffer
entec
onomi
cci
rcums
tanc
es.Fori
nst
anc
e,i
t
c
oul
dbei
ncr
eas
edi
fther
eisagener
alexpec
tat
iont
hati
nter
estr
ateswer
eaboutt
ori
se.

o I
tcons
ider
sthet
imeval
ueofmoneyandt
akest
heoppor
tuni
tyc
ostofmoneyi
ntoac
count
.

Di
sadvant
agesofNetPres
entVal
ue

o I
tisr
eas
onabl
ycompl
ext
ocal
cul
ateandt
oexpl
aint
onon-
numer
atemanager
s

o Thef
inalr
esul
tdependsgr
eat
lyont
her
ateofdi
scountus
ed,andexpec
tat
ionsabouti
nter
est
r
atesmaybei
nac
cur
ate.

o NetPr
esentVal
uec
anonl
ybec
ompar
edwi
thot
herpr
ojec
ts,butonl
yift
hei
nit
ialc
api
talc
osti
s
t
hes
ame.Thi
sisbec
aus
ethemet
hoddoesnotpr
ovi
deaper
cent
ager
ateofr
etur
noni
nves
tment
.

I
nternalRat
eofRet
urn(I
RR)

o TheI
nter
nalRat
eofRet
urnmet
hodc
alc
ulat
est
heexac
trat
eofr
etur
nwhi
cht
hepr
ojec
tsi
s
expec
tedt
oac
hieve,bas
edont
hepr
ojec
tedc
ashf
lows
.Iti
sthedi
scountr
atewhi
ch,when
appl
iedt
othepr
ojec
tedc
ashf
lows
,ens
urest
heyar
eequalt
othei
nit
ialc
api
talout
lay.TheI
RRi
s
t
hedi
scountf
act
orwhi
chwi
llgi
veaNPVofzer
o.I
tist
heac
tualr
etur
nfr
om t
hepr
ojec
t,t
aki
ng
i
ntoac
countt
het
imeval
ueofmoney.

o I
tisc
alc
ulat
ed:

a+b[
c/d]

a.i
sthedi
scountr
atewhi
chgi
vesapos
iti
veNPV.

b.i
sthedi
ffer
enc
ebet
weent
het
wodi
scountr
ates
.

c
.ist
heval
ueofpos
iti
veNPV.

d.i
sthedi
ffer
enc
ebet
weent
het
woNPV'
s.

Page7
Advant
agesofI
nternalRat
eofRet
urn

o Cl
osel
yrel
atedt
oNPV,of
tenl
eadi
ngt
oident
icaldec
isi
ons
.

o Knowi
ngar
etur
nisi
ntui
ti
vel
yappeal
ing.

o I
tisas
impl
ewayt
ocommuni
cat
etheval
ueofapr
ojec
ttos
omeonewhodoes
n'tknow al
lthe
es
timat
iondet
ail
s.

Di
sadvant
agesofI
nternalRat
eofRet
urn

o Mayl
eadt
oinc
orr
ectdec
isi
onsi
ncompar
isonsofmut
ual
lyexc
lus
ivei
nves
tment
s–t
obe
expl
ainedl
ater
.

o Mayr
esul
tinmul
ti
pleans
wer
s(s
ocal
led,Mul
ti
pleI
RRs
)

FULLYWORKEDEXAMI
NATI
ONQUESTI
ONS

1.MrKaybee(
Pvt
)Lt
dwant
stoexpandi
t'
soper
ati
onsi
ntot
hemanuf
act
uri
ngs
ect
or.The
c
ompany'
sfi
nanc
ialmanagerhasi
dent
ifi
edt
wot
ypesofmac
hines
,namel
yAandBf
rom whi
ch
t
heymus
tchoos
eone.

Thet
womac
hineshavet
hes
amepur
chas
epr
iceof$1000000000.Depr
eci
ati
onont
hes
eas
set
s
wi
llbepr
ovi
dedat20% perannum ont
heor
igi
nalc
ostoveraper
iodoff
iveyear
s.Thef
oll
owi
ng
ar
etheexpec
tednetpr
ofi
tsf
rom eac
hoft
het
womac
hinesovert
hef
iveyearper
iod.

Year A B

$000 $000

1. 10000 16000

2. 15000 25000

3. 20000 35000

4. 30000 10000

5. 5000 5000

Theoppor
tuni
tyc
ostofc
api
tali
s15%.Thef
oll
owi
ngdi
scountr
atesappl
y:

Year 15% 30%

1. 0.
870 0.
769

Page8
 2. 0.
756 0.
592

3. 0.
658 0.
455

4. 0.
572 0.
350

5. 0.
497 0.
269

a)Foreachoft
het
womachi
nescal
cul
ate:

i
. t
heac
count
ingr
ateofr
etur
n(ARR)
,

i
i. t
heper
iodofpaybac
k,

i
ii
. t
henetpr
esentval
ue(
NPV)
,

i
v. t
hei
nter
nalr
ateofr
etur
n(I
RR)
.Toc
alc
ulat
etheI
RRus
ethef
ormul
abel
ow.

I
RR=a+b(
c/d)

a.i
sthedi
scountr
atewhi
chgi
vesapos
iti
veNPV.

b.i
sthedi
ffer
enc
ebet
weent
het
wodi
scountr
ates
.

c
.ist
heval
ueofpos
iti
veNPV.

d.i
sthedi
ffer
enc
ebet
weent
het
woNPV'
s.

[
16]

b)Whi
choft
het
womanuf
act
uri
ngpl
ant
sshoul
dthef
irm purchas
e?Expl
ainf
ull
ythereas
on

f
oryourdeci
sions
. [
9]

Ans
wer

(
a) (
i) Account
ingRat
eofRet
urn(
ARR)

ARR = AverageProf
it ×100

AverageI
nves
tment 1

Machi
neA(
$000) Machi
neB(
$000)

Aver
agePr
ofi
t 80000/
5=16000 91000/
5=18200

Aver
ageI
nves
tment 100000/
2=50000 100000/
2=50000

Page9
 ARR 16000/
50000×100 18200/
50000×100

ARR =32% =36.

40%

(
ii) PayBackPeri
od(
PBP)

Not
e:PayBackPeri
odi
sBas
edonCas
hFl
owsonl
y.I
tis
,theref
ore,recommendedt
oconvert
Prof
itsi
ntoCas
hFl
ows
.

Prof
its+Depreci
ati
on=Cas
hFl
ows

Depreci
ati
onf
oreachmachi
ne=20% ×100000000

=$20000000

Machi
neA Machi
neB

Year Prof
its Dep Cas
hFl
ow Cumul
ati
ve Prof
its Dep Cas
hFl
ow Cumul
ati
ve
Cas
hFl
ow(
$000) Cas
hFl
ow(
$000)

0 (
100000) (
100000) (
100000) (
100000)

1 10000 20000 30000 (

70000) 16000 20000 36000 (
64000)

2 15000 20000 35000 (

35000) 25000 20000 45000 (
19000)

3 20000 20000 40000 5000 35000 20000 55000 36000

4 30000 20000 50000 55000 10000 20000 30000 66000

5 5000 20000 25000 80000 5000 20000 25000 91000

Machi
neA(
$000) Machi
neB(
$000)

PayBackPeri
od =2years+35000x12 2years+19000x12

40000 55000

=2years10.
5mont
hs 2years4.
15mont
hs

Page10
 (
iii
) NetPres
entVal
ue:

Machi
neA

Year Cas
hFl
ow D.
F(15%) Pres
entVal
ue Cas
hFl
ow D.
F(30%) Pres
entVal
ue
(
$000) (
$000) (
$000) (
$000)

0 (
100000) 1 (
100000) (
100000) 1 (
100000)

1 30000 0.
870 26100 30000 0.
769 23070

2 35000 0.
756 26460 35000 0.
592 20720

3 40000 0.
658 26320 40000 0.
455 18200

4 50000 0.
572 28600 50000 0.
350 17500

5 25000 0.
497 12425 25000 0.
269 6725

NETPRESENTVALUE 19905 (
13785)

Machi
neB

Year Cas
hFl
ow D.F(
15%) Pres
entVal
ue Cas
hFl
ow D.
F(30%) Pres
entVal
ue
(
$000) (
$000) (
$000) (
$000)

0 (
100000) 1 (
100000) (
100000) 1 (
100000)

1 36000 0.
870 31320 36000 0.
769 27684

2 45000 0.
756 34020 45000 0.
592 26640

3 55000 0.
658 36190 55000 0.
455 25025

4 30000 0.
572 17160 30000 0.
350 10500

5 25000 0.
497 12425 25000 0.
269 6725

NETPRESENTVALUE 31115 (
3426)

(
iv) I
nternalRat
eofRet
urn(
IRR) Machi
neA Machi
neB

=15% +15% (
19905/
33690) 15% +15% (
31115/34541)

=23.9% 28.
5%
Page11
 b) MrKaybees
houl
dpurchas
eMachi
neB.Becaus
e:

 I
thasahi
gherandpos
iti
veAc
count
ingRat
eofRet
urn(
ARR)of36%.

 I
thasas
hor
terPayBac
kPer
iod.

 I
thasahi
gherandpos
iti
veI
nter
nalRat
eofRet
urn(
IRR)
.

 I
t'
sNPVsi
shi
ghert
hanofmac
hineA.

2.MrKaybeeLt
dpr
epar
est
opur
chas
eanew mac
hinec
ost
ing$120000.I
twi
llbes
oldatt
heendof
f
ouryear
sfor$20000.Thec
ompanydepr
eci
atesmac
hiner
yus
ingt
hes
trai
ght
-l
inemet
hod.

Themac
hinewi
llear
nrevenueof$80000perannum andi
nvol
veaddi
ti
onalexpendi
tur
eof$46
000eac
hyear
.Thec
ompany'
scos
tofc
osti
s10%.

Thepr
esentval
ueof$1i
sasf
oll
ows
:

10% 15%

Year 1 0.
909 0.
870

2 0.
826 0.
756

3 0.
751 0.
658

4 0.
683 0.
572

Requi
red

Cal
cul
ate:

a)Theac
count
ingr
ateofr
etur
n(c
ons
idert
hes
aleproceedsoft
hemachi
ne)
;

b)TheNetPr
esentVal
ue;

c
)TheI
nter
nalRat
eofRet
urn.

Ans
wer

a)Annualdepr
eci
ati
on = 120000–20000

= $25000

Aver
agePr
ofi
t = [
$80000–(
46000+25000)
]=$9000

Page12
 Aver
ageI
nves
tment =120000+20000/
2=$70000

ARR =$9000/
$70000×100

ARR =12.
86%

b)TheNetPres
entVal
ue

Not
ethat
:Cas
hFl
ow =Pr
ofi
t+depr
eci
ati
on

Annualpr
ofi
t=$9000

Annualdepr
eci
ati
on=$25000

Year Cas
hFl
ow D.
F(10%) Pres
entVal
ue(
$) Cas
hFl
ow D.
F(15%) Pres
entVal
ue(
$)

0 (
120000) 1 (
120000) (
120000) 1 (
120000)

1 34000 0.
909 30906 34000 0.
870 29580

2 34000 0.
826 28084 34000 0.
756 25704

3 34000 0.
751 25534 34000 0.
658 22372

4 54000 0.
683 36882 54000 0.
572 30888

NetPres
entVal
ue 1406 (
11456)

c
)Int
ernalRat
eofRet
urn

For
mul
a: a+b(
c/d)

I
RR = 10% +5% (
1406/
12862)

I
RR = 10.
55%

Page13
 ENDOFSEMI
NAR
[
MRKAYBEE]

FORASERVI
CETHATGI
VESYOUHONOUR,DI
GNI
TYAND COMFORTCONTACTMRKAYBEEON0718181255(
APP/
CALL)

Page14