UBU134 Financial appraisal of projects

Transcription

1 UBU134 Financial appraisal of projects Unit reference number: H/615/5914 Level: 3 Guided Learning (GL) hours: 50 Overview Business decisions always involve choosing between various alternatives and deciding whether one course of action is preferable to another. Choices may involve a number of different considerations, but the financial implications are certain to be one. This unit introduces the principles of financial project appraisal. By investing in a project one cannot use the cash for another purpose for the time the cash is tied up, thus the unit starts by considering the time value of money. The unit will provide learners with an opportunity to apply common calculations to appraise the returns of projects over time. These include: Net Present Value Internal Rate of Return Return on Capital employed Payment period Learning outcomes On completion of this unit, learners will: LO1 Understand the time value of money LO2 Be able to determine the financial benefits of a project using Net Present Value LO3 Be able to recommend project/investment choices based on Internal Rate of Return LO4 Be able to use the Return on Capital Employed to appraise investment options LO5 Be able to calculate when a project will repay the investment Version 1 1

2 Assessment requirements Learners must complete the assessment requirements related to this unit. Learners must produce a portfolio of evidence which contains assessed evidence covering all the assessment criteria in this unit. 2

3 Unit content LO1 Understand the time value of money Explain the components which contribute to the time value of money: Real rate of interest - What the lender would expect in recompense for supplying the money over the period of time - Depends on The supply and demand for money itself The opportunity cost, i.e. potential earning from other investing options Expected inflation rate - Loss of purchasing power of money Risk Premium - Recompense for the chance of making a loss - Riskier the investment higher the rate of return that tends to be required 3

4 LO2 Be able to determine the financial benefits of a project using Net Present Value Apply Net Present Value (NPV) calculations on future cash flows from a potential project: NPV is used to make investment decisions based on the present value of future cash flows discounted back by a rate which represents the cost of the funds Advantages - Takes into account the time value of money (cost of capital) - Based on forecast cash flows - Values in today s monetary value can be added to compare the return from projects Worked example on Excel spreadsheet - Net present values of a series of cash flows - Period annual - Apply an annual discount rate 1/(1+x/100) t or use BPV function in an Excel spreadsheet x = nominal interest rate or cost of capital t = number of years Recommend whether project is worthwhile - A positive NPV indicates that the project is worth doing financially - A negative NPV suggests it is not worthwhile under current conditions and timespan 4

5 LO3 Be able to recommend project/investment choices based on Internal Rate of Return Demonstrate the use of Internal Rate of Return to decide between two project options: IRR is the discount rate that gives a zero NPV Advantages - Takes into account the time value of money - Gives a % return or yield on investment which managers and investors understand Use IRR function in an Excel spreadsheet Recommend a choice of project/investment decision from alternatives - If the company can raise funds for less than the IIR the project is financially viable - Projects can be compared higher the IRR the better the project 5

6 LO4 Be able to use the Return on Capital Employed to appraise investment options Determine the Return on Capital Employed RoCE to compare two project options: RoCE is the ratio between profit and capital invested - Can be applied to years or whole project - Does not take into account the time value of money RoCE = Average profit per year before interest and tax/average capital employed - Average capital employed = (value at start of period + value at the end of the period)/2 Shows the return as a % of the owner s capital allowing choice of highest return on capital invested 6

7 LO5 Be able to calculate when a project will repay the investment Calculate the payback period of a project: The payback period is the time taken before net cash flows from the project repay the investment in purely cash terms Useful when cash is scarce or where risks are high Worked example - Cumulative cash flows - Payback = payback year + payback month - Payback year + (negative balance at beginning of the next year/positive cash inflow at the end of the year) x 12 7

8 Assessment criteria In order to pass this unit, learners must achieve all pass criteria. The pass criteria relate to the proficient demonstration of skills and knowledge. Learning outcome The learner must: Pass The learner can: LO1 Understand the time value of money LO2 Be able to determine the financial benefits of a project using Net Present Value LO3 Be able to recommend project/investment choices based on Internal Rate of Return LO4 Be able to use the Return on Capital Employed to appraise investment options LO5 Be able to calculate when a project will repay the investment P1 Explain the components which contribute to the time value of money P2 Apply Net Present Value (NPV) calculations on future cash flows from a potential project P3 Demonstrate the use of Internal Rate of Return to decide between two project options P4 Determine the Return on Capital Employed RoCE to compare two project options P5 Calculate the payback period of a project 8