Improvement Service website header

Contact

You might also like...

Prior to conducting an Investment Appraisal

An Investment Appraisal is usually the final stage of a business case; therefore the analyst should have documented, or at least considered the following stages – Identifying Options, Assessing Project Feasibility, Cost-Benefit Analysis, Impact Analysis, Risk Assessment and Recommendations.

 

What is an Investment Appraisal?

This is where the analyst conducts the financial aspects, by referring back to the tangible costs and benefits. There are two main measuring methods used in producing an Investment Appraisal, which are Payback Calculation and Net Present Value/Discounted Cash Flow.

 

Why use an Investment Appraisal?

Using one or more of these methods will provide the analyst and senior management with a better understanding of the finances involved for each option within the business case and whether it’s worth pursuing.

 

How do you document an Investment Appraisal?

As mentioned above, there are two main measuring methods used to produce an Investment Appraisal.

 

Payback Calculation

The first is a payback calculation, which is the simplest out of the two to produce. A payback calculation is often used to provide a cash-flow forecast for a change or development project. In order to produce a payback calculation the analyst must list all tangible costs and benefits. From this the analyst can then start to project the cumulative cash-flow throughout a period of time (example shown below)

Investment Appraisal

Kelly Hunkin

Senior Business Analyst

Tel: 01506 283885

 

Heather Adams

Business Analyst

Tel: 01506 282879

 

Email the Business Analysis team

  Item Year 0 Year 1 Year 2 Year 3 Year 4
Tangible Costs Hardware Costs £200,000 - - - -
Software Costs £150,000 - - - -
Maintenance £60,000 £60,000 £60,000 £60,000 £60,000
Tangible Benefits Staff Savings £150,000 £150,000 £150,000 £150,000 £150,000
  Cash Flow for Year -£260,000 £90,000 £90,000 £90,000 £90,000
  Cumulative Cash Flow -£260,000 -£170,000 -£80,000 +£10,000 +£100,000

By working out the cumulative cash-flow over the period years, we can see that the accumulated benefits exceed the accumulated costs by year 3, and build up there afterwards.

 

Net Present Value/ Discounted Cash Flow (NPV/DCF)

The next method is known as NPV/DCF. This method takes account of the time value of money. This means that all cash-flows are adjusted to today’s value of money. The DCF rate is often determined by accountants, but can be worked out by the analyst by studying a number of financial factors. Let’s assume that the accountant has calculated the discount rate of 10%, and we then apply it to the same example as shown above.

Year Net Cash Flow Discount Factor Present Value
0 -£260,000 1.000 -£260,000
1 £90,000 0.909 £81,810
2 £90,000 0.826 £74,340
3 £90,000 0.751 £67,590
4 £90,000 0.683 £61,470
Net Present Value of Project: £25,210

We can now see that the project is not as attractive as it first appeared in the payback calculation. The project still profits but only after the 4th year and only by £25,210 instead of +£100,000.

 

It is always worth the analyst’s time to develop a payback calculation followed with a NPV/DCF. This will just keep everything in perspective.

What happens next?

By this point you should be looking at the completion of the business case. From here, the analyst would take it forward to the senior management team. If the senior management team agree to go ahead with one of the options, it will then be up to the analyst to start establishing requirements for the approved change or development project.

 

 

Return to Business Analysis Framework

 

phone icon
Our address
COSLA logo SOLACE logo

© Improvement Service, 2017. All Rights Reserved