Description
Discussion 1
Pogue (2004) and Gotze et al (2015) emphasise the importance of investment appraisal in corporate finance for assessing project profitability and feasibility and influencing financial decisions like capital structure and dividend policy. They suggest techniques such as sensitivity analysis, scenario analysis, and real options and propose a new approach using continuous discount factors to capture cash flow timing and frequency.
Baum et al (2021) argue that payback could be an adequate investment appraisal method due to its disregard for the time value of money and project total return. They criticise payback for favouring short-term projects and failing to consider future cash flow risk. Discounted cash flow methods are more rational and objective, considering present value and expected return. Alshawi et al (2003) argue that payback is invalid due to its traditional approach, which does not consider the broader intangible and non-financial implications of IT and may hinder organisations from implementing IT infrastructure for long-term competitiveness.
How can investment appraisal methods be improved to account for financial and non-financial factors in IT projects? (300 words)
Discussion 2
“In reality, investment appraisal is a waste of time given the problem of establishing accurate long-term project cash flows.”
Investment appraisal involves various techniques and methodologies to assess the feasibility and profitability of a project. While predicting future cash flows is uncertain and challenging, it does not render the entire process useless (Damodaran, 2012).
Consider a technology company planning to invest in the development of a new product. While predicting the exact sales figures and costs over the next ten years might be difficult, conducting a thorough investment appraisal can still provide valuable insights into potential risks and rewards. Sensitivity analysis and scenario planning can be employed to assess the impact of varying cash flow assumptions.
“Despite ignoring the time value of money and total return, payback is a valid method of investment appraisal.”
The payback period, which measures the time it takes for an investment to recoup its initial cost, is a straightforward method but has limitations. Ignoring the time value of money and total return can be problematic, as it neglects the fact that money has a time-based value, and doesn’t account for cash flows beyond the payback period.
Suppose Company A is considering two projects with similar payback periods. Project X recovers its initial investment quickly, but Project Y, while taking longer to pay back, has a higher overall return. Ignoring the time value of money could lead to choosing Project X, which might not be the most lucrative option in the long run.
In the “Principles of Corporate Finance,” Brealey et al. (2022) discuss the limitations of the payback period as an investment appraisal method and look for more sophisticated techniques like Net Present Value (NPV) that consider the time value of money and provide a more comprehensive view of a project’s profitability.
Do you believe that traditional financial metrics, such as payback period and internal rate of return, are still sufficient for investment appraisal? or do we need to explore and incorporate new approaches to better capture the complexities of modern projects? (300 words)
Discussion 3
From my perspective, investment appraisal is of paramount significance in the decision-making process. The crux of decision-making involves evaluating the cost of implementation against the anticipated future benefits (McLaney & Atrill, 2023). This rationale extends to the forecasting of future cash flows, revenues, and costs over an extended period—a task laden with inherent uncertainties stemming from external factors, such as market fluctuations or technological advancements.
Navigating the practicalities of an uncertain business environment goes beyond theoretical concepts. While the accuracy of predicting cash flows poses significant challenges, investment appraisal persists as a valuable instrument for gauging potential profitability and risk. Employing ‘conventional’ methods, such as sensitivity analysis and scenario planning (Alkaraan & Northcott, 2006), allows us to scrutinize how varying assumptions about cash flows influence a project’s viability.
In essence, investment appraisal, though not infallible, furnishes a structured approach to assess investment opportunities and make informed decisions despite the unpredictability of cash flow projections. It stands resilient as a compass in the dynamic landscape of decision-making, offering insights that transcend the uncertainties inherent in forecasting.
According to Götze et al. (2007), the payback period of an investment project refers to the time it takes for the initial capital investment to be recovered from the average excess cash flow created by the project. It offers a means of evaluating returns and assessing risk, based on projected cash flows. Despite ignoring the time value of money as other ‘conventional’ investment appraisal methods (e.g. NPV or IRR), it can still serve as a useful tool for investment appraisal for non-scalable projects (Alkaraan & Northcott, 2006) that are more short-term oriented, aiming to maximize liquidity and minimize risk (Kaplan Financial Knowledge bank, n.d.).
Nevertheless, the static payback period method is a simplistic approach with limitations. Still, it can offer a quick and intuitive assessment of project liquidity when used in conjunction with more sophisticated techniques like NPV and IRR.
How can organizations strike a balance between the simplicity of the static payback period method and the imperative for a more intricate evaluation to ensure a comprehensive assessment of investment projects? (300 words)
Discussion 4
Hi everyone,
I’d like to share my opinion on the topic of Unit 8 as follows.
In reality investment appraisal is a waste of time given the problem of establishing accurate long term project cash flows. Do you agree?
Before taking any investment decision, it’s essential that proper screening of investment proposal should be taken into account (McLaney & Atrill, 2023) to assess the profitability and feasibility of a project. I don’t agree with the statement that investment appraisal is a waste of time as when it comes to business, managers should not rely on their “gut feeling” to find businesses, but use formal appraisal techniques to analyse and evaluate investment opportunities. The benefit of conducting investment appraisal is to help managers to assess the profitability and return on investment from a project compared against the risk, which allows them to forecast the financial revenue of and the associated costs an investment decision. According to McLaney & Atrill (2023), there are basically four techniques used by businesses to assess investment opportunities including accounting rate of return (ARR); payback period (PP); net present value (NPV); and internal rate of return (IRR), each of which has its own advantages and disadvantages. Hence, before conducting an investment appraisal, it’s necessary for managers to assess the feasibility of the project, conduct a cost-benefit analysis, and an impact analysis and risk assessment related to each technique.
Despite ignoring the time value of money and total return, payback is a valid method of investment appraisal. Do you agree?
The payback (PB) period is the time it takes for an initial investment to be repaid by the net cash inflows generated from a project (McLaney & Atrill, 2023). While PB method has certain advantages including its simplicity that is the quick and easy to calculate and easily understood by managers without accounting and finance background (Velnampy, 2006), the reflection of a project’s liquidity and risk, the use of cash flows (rather than accounting account), etc., it is not, however, a complete technique to appraise an investment opportunity. According to Yard (2000), PB is used as the single criterion in investment appraisals and seems to have decreased over time.
One of the major limitations of the PB method is that it skips the time value of money (that does not account for the fact that the value of dollar changes over time and does not consider the opportunity cost of capital, inflation, interest rates) and does not take into account cash flows after the payback period (Yard, 2000). Also, as argued by Lefley (1996, as cited in Yard, 2000), PB technique ignore the profitability of a project, but measure its time risk and its effect on liquidity.
Question: With the limitations of PB method mentioned above, in your opinion, what are the solutions to reduce those PB deficiencies? (300 words)
