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Projeect Appraisal Gimpa
Projeect Appraisal Gimpa
Projeect Appraisal Gimpa
organizational Checklist
appraisal Whether the entity is properly organised do the job
Strength to use capability and take initiatives to reach
the objectives
Openness to new ideas and willingness to adopt long
term approach to extend over several projects
The demand and scope of the project among the
beneficiaries, customer friendly process and
preferences, future demand of the supply,
effectiveness of the selling arrangement, latest
information availability on all areas, government
control measures, etc.
Commercial
appraisal The appraisal involves the assessment of the
current demand/market scenario, which enables
the project to get adequate demand.
Estimation, distribution and advertisement
scenario should be considered too.
To see any detrimental environmental impacts and
how to minimise the impacts.
Environmental appraisal concerns with the impact
of environment on the project.
The factors include the water, air, land, sound,
Environmental geographical location etc.
appraisal Environmental considers how an organisation
performs as a steward of nature. This factor
includes the nature and extent of non-
renewable resources used in production, as
well as the release of potentially harmful
elements to the air, land or water.
How far the project contributes to the
development of the sector, industrial
development, social development, maximizing
Economic the growth of employment, etc. are kept in view
appraisal while evaluating the economic feasibility of the
project.
To determine whether the project
satisfies the legal issues related to land
acquisition, title deed, environmental
Legal appraisal
clearance etc.
This analyses the risk and uncertainties
associated with the project and identifies
Risk appraisal strategies to mitigate or manage those
risk
This assesses the social impact of the project, including
its effect on community and stakeholder groups, and its
alignment with local and national policies and priorities.
Social examines how an organisation manages
relationships with employees, suppliers, customers
and the communities where it operates.
Social Social issues range from human rights and health
appraisal and safety to other responsible business practices,
such as product marketing and privacy.
Expectations around these issues, as well as
environmental issues, define what is often referred
to as the social license to operate.
Governance deals with an organisation’s
leadership and effective management of the
business. In addition to overseeing strategy
execution, performance and management of
risks, effective governance ensures
maintenance of the social license to operate.
Governance
appraisal
Specific governance considerations include
executive pay, regulatory compliance, and
shareholder rights, as well as internal
controls and internal and external audits.
Cash flow estimation is an integral part of the valuation
and capital budgeting process.
Cash flow estimation is a necessary step for assessing
investment decisions of any kind.
Project cash flows consider all kinds of inflows of cash.
The estimation of cash flows is done through the
Estimation of coordination of wide range of professionals involved in
the project.
cash flows The engineering department is responsible for forecasting of
capital outlays.
The production team is responsible for forecasting operational
costs.
The marketing team is basically involved in forecasting
revenues.
The finance manager has the responsibility to collect data and set
The most important variable in estimating cash flows are the firm’s
future sales growth and profit margins.
Estimation of growth rates is an important determinant of cash flow
estimation.
A firm’s revenue growth rate is based on a number of factors like
industry trends, economic environment, and company’s competitive
Estimation of advantage.
cash flows The costs incurred by firms are a major factor for determining the
company’s future operating profits.
Companies that are heavily dependent on oil and natural gas face wide
swings in profit margin if the price of the raw materials increases.
Operating leverage is a factor that determines the profitability position
of a firm. As a company grows, it must be able to spread its fixed costs
across a broader base of production.
Initial outlay
For expansion projects, this will consist of the cash flows
resulting from acquiring the new asset and will consist of:
a. The Purchase price of the new asset
b. Installation costs of the new asset e.g. transportation,
shipping, handling etc.
Estimation of c. Increases in working capital requirements e.g. inventory
cash flows i.e. raw materials, finished goods etc
d. After-tax non-capital expenditures e.g. costs to train
employees to operate asset
e. Investment tax credit (ITC) given by government due to
the nature of the company's business. (This ITC could be
given at any time during the project's life).
Cash inflows
This is usually based on the revenue of
the project.
With revenue we are referring to the
sales of the project.
Estimation of One need to consider the growth rate
cash flows and other factors in the economy in
other to accurately estimate the cash
inflows.
We shall look at a case for illustration
Case study on project appraisal
PASK is a car rental company located in Ghana is considering setting up a division to provide
chauffeur driven Bugatti for weddings and other events. The proposed investment will include the
purchase of a fleet of 25 Bugatti at a cost of GH¢200,000 each. It is estimated that the Bugatti will have
a useful life of five years and a resale value of GH¢30,000 each at the end of their useful life. The
company uses the fix instalment method of depreciation.
Revenue and variable costs
Each Bugatti will be hired to customers for GH¢1,000 per day. The variable costs, including fuel,
cleaning and the chauffeur’s wages, will be GH¢500 per day. The Bugatti will be available for hire 350
days of the year. A market specialist was hired at a cost of GH¢50,000 to estimate the demand for the
Bugatti in Year 1. The market specialist estimated that each Bugatti will be hired for 260 days in Year 1
and that the number of days’ hire will increase by 15 days each year for the remaining life of the projec
Fixed costs
Estimation of Each Bugatti will incur fixed costs, including maintenance and depreciation, of GH¢50,000 a year. The
administration of the division is expected to cost GH¢355,000 each year. The garaging of the Bugatti
will not require any additional investment but will utilize existing facilities which there is no other use.
cash flows The head office will charge the division an annual fee of 10% of sales revenue for the use of these
facilities.
Taxation
The company’s financial director has provided the following taxation information:
Tax depreciation: 20% per annum on the reducing balance, with a balancing adjustment in the
year of disposal. The Bugatti will be eligible for tax depreciation.
Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises, the
balance is paid in the following year.
Other information
Inflation rate is 18%
The company uses a cost of capital of 12% per annum to evaluate projects of this type
Required:
Estimate the free cash flow for this project and using the various appraisal techniques advise
whether the project is viable
There are number of appraisal methods which may be
recommended for evaluating the capital investment
proposals.
We shall discuss the most widely accepted methods.
These methods can be grouped into the following
categories:
APPRAISAL
Traditional or non-discounted cash flow methods
TECHNIQUES Payback Period
Accounting Rate of Return (ARR)
Time adjusted methods or discounted cash flow methods
Net present value (NPV)
Profitability index (PI) or Cost-benefit ratio (CBR)
Internal rate of return (IRR)
Pay-back period is also termed as "Pay-out period" or Pay-
off period. Pay-out Period Method is one of the most
popular and widely recognized traditional method of
evaluating investment proposals. It is defined as the
number of years required to recover the initial investment
in full with the help of the stream of annual cash flows
Period
The payback period is the most basic and simple decision
tool. T. Lucy (1992) defined pay-back period as the period,
usually expressed in years which it takes for the project’s
net cash inflows to recoup the original investment. The
usual decisions rule is to accept the project with the
shortest pay-back period.
Pay-back period can be calculated using the
following two different situations:
In the case of constant annual cash inflows.
In the case of uneven or unequal cash inflows.
In the case of constant annual cash inflows
Payback If the project generates constant cash flow the Pay-
Period back period can be computed by dividing cash
outlays (original investment) by annual cash
inflows. The following formula can be used to
ascertain pay-back period:
Pay-back Period =
A project requires initial investment of GH
¢400,000 and it will generate an annual cash inflow
of GH¢80,000 per year for 6 years. You are
required to find out pay-back period.
Solution
Payback
Period Calculation of Pay-back Period:
Pay-back Period =
Pay-back Period = = 5 years
Pay-back period is 5 years, i.e., the investment is
fully recovered in 5 years.
In the case of uneven or unequal cash inflows
In the case of uneven or unequal cash inflows, the
Pay-back period is determined with the help of
cumulative cash inflow. It can be calculated by
Payback adding up the cash inflows until the total is equal
Period to the initial investment. We can use the following
formula as a guide:
Pay-back Period = Year before full recovery +
An organisation wants to embark on an investment.
It has been presented with the cashflows for two projects and would want to decide with of the two projects to invest
in. Using pay-back period method, help the organisation decide.
Year Project A Project B
Cash flows Cash flows
1 GHS12,500 GHS5,000
2 12,500 10,000
Payback
3 12,500 15,000
Period
4 12,500 15,000
5 12,500 25,000
6 12,500 30,000
3 15,000 30,000
5 25,000
Accept or Reject Criterion
Investment decisions based on pay-back
period used by many firms to accept or
reject an investment proposal.
Among the mutually exclusive or
alternative projects whose pay-back
Payback periods are lower than the cut off period
Period the project would be accepted; if not it
would be rejected.
The usual decisions rule is to accept the
project with the shortest pay-back
period.
Accounting Rate of Return Method is also termed as
Average Rate of Return Method.
This method focuses on the average net income
generated in a project in relation to the project's average
investment outlay.
Accounting Rate of This method involves accounting profits not cash flows
Return (ARR) and is similar to the performance measure of expected
Method return of return.
The accounting rate of return can be determined by:
ARR =
Or
ARR =
Average investment would be equal to the
Original investment plus salvage value divided
Accounting by Two.
Rate of Return
(ARR) Average Investment =
Method Or
Average Investment =
From the following information you are required
to calculate Accounting Rate of Return:
An investment with expenditure of GHS100,000
is expected to produce the following profits (after
deducting depreciation)
Accounting
Rate of Return 1st Year GHS8,000
Profit after
depreciation 20,000.00 40,000.00 60,000.00 80,000.00 120,000.00 320,000.00
Accounting
Net profit after
tax 16,000.00 32,000.00 48,000.00 64,000.00 96,000.00 256,000.00
= × 100. = 17%
The net present value decision tool is a more common and
more effective process of evaluating a project.
The NPV tool is effective because it uses discounted cash
flow analysis, where future cash flows are discounted at a
discount rate to compensate for the uncertainty of those
future cash flows. Independent projects are accepted when
Net Present NPV is positive and rejected when NPV is negative.
Value (NPV) In the case of mutually exclusive projects, the project with
the highest NPV is accepted. Despite a strong academic
preference for NPV, surveys indicate that executives prefer
IRR over NPV although they should be used in concert. In
a budget-constrained environment, efficiency measures
should be used to maximize the overall NPV of the firm.
It is assumed that an investment with a positive NPV
will be profitable while an investment with a negative
NPV will result in a loss.
NPV = PV of Inflows - Initial Outlay
NPV = [ + + + …. + ] – I0
Net Present Where:
Value (NPV) NPV = Net Present Value
CF = Future Cash Inflows at different times
r = Cost of Capital or Cut-off rate or Discounting
Rate
I0 =Cash outflows at different times OR Initial
investment
Calculate the Net Present Value of the following project requiring an
initial cash outlay of GHS20,000 and has a no scrap value after 6
years. The net profits after depreciation and taxes for each year of
GHS6,000 for six years. Assume the present value of an annuity of
GHS1 for 6 years at 8% p.a. interest is 4.623.
Solution:
Calculation of Net Present Value
Net Present Initial cash outlay = GHS20,000
Value (NPV) Present value of cash inflows = GHS6,000 x 4.623
= GHS27,738
Net Present Value= Present Value of Cash Inflows – Io
= GHS27,738 – GHS20,000
= GHS7,738
Net Present Value= GHS7,738
An investor has GHS10,000 to under a project. He has
been presented with two possible projects and their
expected cash inflows. Assuming that the rate of return is
15%, calculate the NPV for the projects and decide on
which one to invest in.
Project A Project B
Net Present Year 1 GHS2,500 GHS3,750
(10,000.00
0 (10,000.00) ) 1.0000 (10,000.00) (10,000.00)
(2,874.73) 145.29
Rules of Acceptance
If the rate of return from a project is greater than the return from an
equivalent risk investment in securities traded in the financial market,
the Net Present Value will be positive. Alternatively, if the rate of
return is lower, the Net Present Value will be negative. In other words,
if a project has a positive Net Present Value it is considered to be
Net Present viable because the present value of the inflows exceeds the present
value of the outflows. If the projects are to be ranked or the decision is
Value (NPV) to select one or another. the project with the greatest Net Present Value
should be chosen. Symbolically the accept or reject criterion can be
expressed as follows:
Where
NPV > Zero Accept the proposal
NPV < Zero Reject the Proposal
Profitability Index is also known as Benefit Cost Ratio. It
gives the present value of future benefits, computed at the
required rate of return on the initial investment.
Profitability Index may either be Gross Profitability
Index or Net Profitability Index. Net Profitability Index is
Profitability the Gross Profitability Index minus one. The Profitability
Index Method Index can be calculated by the following equation:
Profitability Index =
Or
Profitability Index =
EmmaSey Limited is considering the purchase of a new photocopier machine to
increase its production. The company has the policy of charging depreciation on
straight-line basis. Assuming the company’s weighted cost of capital (WACC) is 10%
and a tax rate of 20%. The following information relates to the project.
26,000
2 19,000
3 24,000
4 20,000
5 2,000
Calculate the Profitability Index and advise the company whether to buy the machine.
Depreciation = = = GHS18, 000
YEARS 1 2 3 4 5
Profit before
depreciation and
tax 26,000.00 19,000.00 24,000.00 20,000.00 12,000.00
Depreciation
6,400.00
18,000.00
800.00
18,000.00
4,800.00
18,000.00
1,600.00
18,000.00
(6,000.00)
18,000.00
(10,000.00
0 (10,000.00) ) 1.0000 (10,000.00) (10,000.00)
Internal Rate 1 2,500.00 3,750.00 0.8696 2,173.91 3,260.87
of Return 2 2,000.00 3,750.00 0.7561 1,512.29 2,835.54
(IRR) Method
3 1,875.00 2,500.00 0.6575 1,232.84 1,643.79
(2,874.73) 145.29
CASHFLO CASHFLO PRESENT PRESENT
W W DISC. VALUE VALUE
(PROJECT (PROJECT FACTOR (PROJECT (PROJECT
YEAR A) B) (12%) A) B)
(2,342.20) 823.77
IRR = a +
Internal Rate of Return for Project A (IRRA)
IRRA = 10% +
IRRA = 10 +
(IRR) Method
IRRA = 10 + (
IRRA = 10
IRRA = 0.083%
Decision rule
If the IRR of a new project exceeds a
company’s required rate of return, that
project is desirable so should be
Internal Rate accepted.
of Return
On the other hand, if IRR falls below
(IRR) Method the required rate of return, the project
should be rejected. If the projects are
mutually exclusive, accept the project
with the highest IRR.
End
Thank you
seyram kawor