Investment Appraisal Methods Essay

Words: 2466
Pages: 10

What is meant by investment appraisal practices?
The investment appraisal process includes the generation of ideas, assessment and authorization, implementation and control of the project (Dennis R. Young, 2007). Decision-making is increasingly more complex today because of uncertainty. Additionally, most capital projects involve numerous variables and possible outcomes. For instance, estimating cash flows associated with a project involves working capital requirements, project risk, tax considerations, expected rates of inflation, and disposal values. It is necessary to understand existing markets to forecast project revenues, assess competitive impacts of the project, and determine the
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today, the day of the investment). Therefore we need to convert all cash flows into present values, today’s values.
Interest rate, Discount rates and Real rates
An interest rate is the proportionate return on an investment appropriate for the risk level of the investment. So it could be the return on a bond, a company’s investment or the required return a company has to pay on its loan. The expression discount rate is often used synonymously with interest rates because the discount factor is derived using an interest rate. Similarly, because companies use a mixture of capital types to fund their investments, that mixture have an average cost which the company has to service. Any investments made from that mix of capital must generate flows and in the evaluation of those flows the discounting process is used. The expressions cost of capital, opportunity cost of funds are used, as alternatives to discount rate since the discounting factor is derived using the cost of capital.
The terms, money and actual interest rates, are used to mean nominal rate. The nominal rate is the rate to be found in the market place. The real rate is the rate of interest that would persist if there were no inflation or deflation.
(1 + real rate)(1+ inflation rate) = (1 + nominal rate)
(1+ r)(1+ i) = (1+ n)
N.B. Note the