1 Capital investment appraisal

1.1 Introduction
1.1.1 long term decisions
=1

time value of money

1.1.2 long term investment

the purchase of buildings, machinery and equipment.

=2

estimates

See also: long term decisions

=1 =2 =3

initial investment future costs future revenues

1.2 Interest
1.2.1 money investment earns over time 1.2.2 Classify simple interest equal amounts every year (month)
=3

proportion of the original investment

principal

S = P + nrP
S: the sum invested after n periods P: the orginal sum invested

r: the interest rate n: the number of periods (year/month)

compound interest See also: effective interest rates interest earned will earn interest in later periods S = P (1+r)^n See also: P = S*1/(1+r)^n
P: the original sum invested r: the interest rate n: the number of periods (year/month) S: the sum invested after n periods

effective interest rates annual rate of interest

made annual interest from daily, weekly, monthly, quarterly interest

interest is compounded daily, weekly, monthly... [(1+r)^(12/n) - 1] n: months [(1+r)^(365/y) - 1] y: days nominal interest rates See also: effective interest rates per annum figures interest is compounded over (less) than one year

1.3 Principles of discounted cash flow

1.3.1 present value
=4

discount factor

See also: P = S*1/(1+r)^n

=4

1/(1+r)^n

money invested to earn future sum discounting formula P = S*1/(1+r)^n

P: present value S sum to be received after n time periods r: rate to return, expressed as a proportion n number of time periods

=5

r: cost of capital

1.4 Annuities, perpetuities

1.4.1 annuity
=6

annuity factors

cumulative present value factors

=5

[1 - (1+r)^(1/n)]/r

constant sum of money for a given number of years Present value of an annuity = Annuity * annuity factor 1.4.2 perpetuity annuity forever Present value of an perpetuity = annuity / interest rate 1.4.3 profits matching concept net See also: net

1.4.4 cash flows net

difference between the payments leaving an organisation's bank account and the receipts paying into the bank account.

1.5 Capital investment appraisal

1.5.1 net present value method See also: Principles of discounted cash flow present values - investment
=7

timing
=6

note: first payment falls now first year ...

=1 =2 =3

positive
acceptable

negative
unacceptable

1.5.2 internal rate of return method See also: Principles of discounted cash flow, net present value method rate of interest See also: P = S*1/(1+r)^n
=8

internal rate of return

NPV = 0 approximate IRR graphical method sketch graph of NPV against discount rate See also: NPV = 0

interpolation method IRR = a% + [NPV(A)/(NPV(A) - NPV(B))*(b-a)]%

a: one interest rate b: other interest rate NPV(A): NPV at rate a NPV(B): NPV at rate b

1.5.3 payback method payback period time required cash inflows = cash outflows
=9

capital investment project

See also: apprise

Example
=10

Note profit before depreciation

=7

See also: cash inflows = cash outflows

cash flow
=8

profit after depreciation

profit after deprecation + depreciation = cash flow

apprise shortest payback period payback period limit discounted payback See also: Principles of discounted cash flow

time cumulative NPV turn from negative to positive