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Home > Business Strategy Checklists > Appraising Investment Opportunities

Business Strategy Checklists

Appraising Investment Opportunities


Checklist Description

This checklist outlines how to appraise investment opportunities.

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Definition

As a rule, one of the most critical decisions for any business is long-term investment. This investment can be the purchase of land, buildings, machinery, or other assets in the expectation of earning an income over and above the funds committed. Appraisals are performed to find out whether such investments will yield returns to an organization over a period of time. The appraisals look at the outflows and inflows of funds, the duration of the investment, the scale of risk attached, and the cost of acquiring the funds.

The critical questions in an investment appraisal are:

  • What is the extent of the investment, and can the business meet the expense?

  • How long will it take to pay back the investment?

  • When will the investment start to yield returns?

  • What is the return on the investment?

  • Would the money be better employed elsewhere?

The methods used when conducting an investment appraisal are:

  • Payback: The amount of time needed to repay the initial investment.

  • Average rate of return: The profits from an investment as a percentage of the initial capital cost.

  • Net present value: Uses opportunity cost (i.e. the cost of an alternative choice when making a decision that must be given up in order to follow a certain action) to put a value on cash inflows from the capital invested.

  • Internal rate of return: The annual percentage return on an investment when the sum of the discounted cash inflows over the life of the investment is equal to the sum of the capital invested.

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Advantages

  • Investment appraisals allow managers to make long-term plans on the projects that will yield the best returns for the business.

  • Payback is easily understood and calculated.

  • Average rate of return is easily understood and employs commonly used accounting rules.

  • Net present value recognizes that a business incurs costs, such as interest on borrowing.

  • Internal rate of return shows how well an investment will perform under different interest rates.

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Disadvantages

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Action Checklist

  • Identify the key investment objectives for the organization and plan around those objectives.

  • Have realistic in-depth budgets been calculated?

  • Will rapid technological change make plant and machinery obsolete sooner and, therefore, will the payback period need to be shortened?

  • Are resources invested in the most profitable objectives, and what alternatives are available?

  • Has a risk analysis been carried out on the project to take into account risks and their impact?

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Dos and Don’ts

Do

  • Take into account the duration and timing of cash flows.

  • Consider how emerging risks necessitate regular reviews, and how risks such as new technology might affect the long-term viability of the project.

  • Involve key stakeholders in an investment appraisal.

  • Consider seeking the help of specialist consultants.

Don’t

  • Don’t make the mistake of being attracted to a project that has not been thoroughly investigated and appraised.

  • Don’t take risks for granted; although a risk may have been the same in the past, there is no guarantee that it will be the same in the future.

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Further reading

Books:

  • Langdon, Ken. Investment Appraisal. Oxford: Capstone, 2002.
  • McLaney, Eddie. Business Finance: Theory and Practice. 9th ed. Harlow, UK: Pearson Education, 2011.
  • Pettinger, Richard. Investment Appraisal: A Managerial Approach. Basingstoke, UK: Palgrave Macmillan, 2000.

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