Investment Plan Assignment Example | Topics and Well Written Essays - 2000 words

Investment Plan - Assignment Example 2. Accounting Rate of Return: Accounting Rate of Return is based on accounting profit. Accounting Rate of Profit (ARR) can be defined as the percentage of Average Annual Profit of an Investment to the Average Investment. Where, Average Investment = (Initial investment + scrap value) / 2 Advantages: By using Profit figures, this technique relates to the return on capital employed directly. The result of this calculation is in percentage, which is easily understandable by most business people. Disadvantage: Here also it ignores the time value of money It uses the accounting profit rather than cash flows. Cash flows represent solid power over resources, whereas Accounting profits are subjected to the application of accounting concepts. 3. Net Present Value: It is a discounted cash flow method of investment appraisal. It uses the method of discounting future cash flows to its present values. The sum of the future cash flows less the initial investment gives the Net Present value of a Project. Advantages: Its main strength is its recognition of time value of money. As it considers cash flow for calculation, it is not affected by the accounting policy of a particular company. As it takes account of the costs of raising finance, a positive NPV reflects the increase in shareholders' wealth, which is supposed to be the main consideration of Project appraisal. Disadvantages: This is a bit cumbersome process of calculating the discount rate with the nature of finance available. It gives result in absolute figures, and does not allow for the size of the project. 4. Internal Rate of Return: Internal Rate of Return is the discount rate that gives a zero NPV....The sum of the future cash flows less the initial investment gives the Net Present value of a Project. 4. Internal Rate of Return: Internal Rate of Return is the discount rate that gives a zero NPV. The acceptance criteria of this method of appraisal are; IRR should be greater than the discount rate on the presumption that a project with higher IRR than the discount rate generates higher returns. Calculation of IRR is easier as it does not require precise cost of capital discount rate. To accept a project it is enough to see that the IRR sufficiently higher than the approximate cost of capital. To summerize complex accounting information into relatively small no. of key indicators ratios are used. This also makes comparison easier. As we are now going to make comparison between the performance of M/s Sukna and M/s Badra we should utilize the ratio analysis method. Traditionally ratios are classified into five groups. We should look into the ratios for which data is available with us. This is known as primary ratio as it goes to the heart of what most private sector firms try to achieve. This ratio gives the effectiveness of the assets financed both by shareholders and long term creditors. This ratio should be as high as possible. Gross Profit Margin = Gross Profit / Sales X 100%. This ratio does not give a clear picture but it can give some trend.