#### INVESTMENT APPRAISAL TECHNIQUES AND THEIR APPLICATIONS BY FINANCE/ INVESTMENT HOUSES (A CASE OF UNION BANK PLC ENUGU URBAN)

DEFINITION NATURES AND CONCEPT OF INVESTMENT DECISION

According to Okafor (1983) investment refers to economic activities designed to increase improve or maintain the productive quality of the existing stock of capital. Osuagwu (2003) defined it as the ploughing of one’s finance or fund into project or assets (be it tangible or financial assets) with a view of increasing one’s wealth.

For an economic unit (persons or firms) investment occurs whenever there is an addition to capital stock. The purchase of machinery or factory building represents investment for the individual investor just as much as the purchase of equity shares or other securities

In macro- economy only additions to real assets can correctly be described as investment. This arises from the fact that most changes in the ownership of financial asset tend to cancel out with in an economy leaving intact the initial stock of such securities.

In the book of T. Lucy (1998, 409) investment decision are regarded as long decision where consumption and investment alternative are balanced over time in the hope that investment now will generate extra returns in the future. The firm investment decision would generally including; expansion, acquisition modernization and replacement of the long-term asset. Sales of a division or business is also regarded as an investment decision.

The following are feature of investment decision.

- The exchanging of current funds for future benefits.
- The future benefits will occurs to the firm over a series of years.
- One such decision are taken they become irreversible or sunk.

It’s important to mention that expenditure and benefits of an investment should be measured in cash. In the investment analysis it is cash flow that is important and not the accounting project investment decision effete the value of the firm in the sense that firms value will increase if investment are profitable and added to the shareholders wealth.

2.2 IMPORTANCE AND TYPE OF INVESTMENT DECISION

Nweze (2001) states that the importance of capital budgeting lies in the fact that it has a long term implication involving tying a firms scarce funds into project that the expected benefit will occupied in future years. As a result any faulty decision bead the firm into wasteful expenditure involving invented expansion of asset which will entail unnecessary heavy operation of cost to the firm since investment decision once made is irrevocable and becomes sunk.

There are various types of investment that a firm can undertake at any given time depending on its objective or aim some of them includes;

REPLACEMENT INVESTMENT: In this type of investment the objective are to replace worn out or obsolete asset with new ones in order to sustain the level of productive activity. In most cases the funds to be realized in this type of investment are provided internally through depreciation.

EXPANSION INVESTMENT: This can be two types expansion of existing business and expansion of new in the expectation of additional revenue. This increasing the current asset capacity is the bone of contention here in order boost production.

MODERNIZATION OR IMPROVEMENT INVESTMENT: The main objective of this type of to improve operating efficiency and cost reduction. Saving will reflect in the increased profits but the firm’s revenue may remain unchanged. Thus company may opt to use more sophisticated machine that will reduce cost.

- CONCEPT OF INVESTMENT APPRAISAL

Investment analysts as we have said entail the efficient evaluation of capital expenditure using certain criteria usually know as investment appraisal technique. According to Osuagwu (2003) it is a means of assessing whether capital expended on a project would show a satisfactory rate of return on a project undertaking either absolutely or when compared with expenditure on alternative project and indicating the optimum time to invest.

Investment appraisal has the following procedures

- Project generation
- Project evaluation
- Project selection
- Project execution

- INVESTMENT APPRAISAL TECHNIQUES

Orji (2001) categories investment appraisal techniques into two broad approaches:

- Traditional/ non discounting technique
- Discounted cash flow techniques

NON DISCOUNTING APPROACH

This is usually referred to as the non-discounted cash flow (non D.C.F) Technique. It evaluates.

Some of the criterion used under this approach are the pay back period (urgency method) (PBP) and the accounting rate of return (average rate of return) (ARR)

THE PAY BACK PERIOD (PBP)

Osuagwu (2003) defined the pay back period as the number of years required to recover the original cash outlay invested in a project. It is the number of year required from the stream of cash proceeds generated by an investment to equal the original cost of the investment.

ILLUSTRATION: A project required cash outflow of N50,000 to generate cash flow of N25000 for three year. What is the pay back period of this investment?

The payback = cash outflow annual cash into

= 50000

yr1 = (25000)

yr2 = (25000) = 2yrs.

Suppose the same investment will yield cash inflow of N15,00, N20000 and N25000 for the first through to the fifth year. The pay back period will be computed as follows. In the first & second year N35000 (N15000 +N2000) of the initial cash outflow of N50000 was recovered remaining N15000 (N5000-N35000) N1500 which will be recouped from the third year cash outflow of N25000

__N15000 __ x __12__

N25000 1 = 7.2 months

It there means that the pay back period for this investment proposal is 2yrs and 7months

ADVANTAGE OF THE PAY BACK METHOD

- Simple to calculate and understand.
- Uses project cash flows
- favours quick return project which may produce faster growth for the company and enhance liquidity

DISADVANTAGE OF THE PAY BACK METHOD

- It ignores all post recovery period accruals
- It ignores the profitability of the projects since it is pre-occupied with speed of repayments
- It fails to consider the timings of the cash flows (ie) the time value of money.

ACCOUNTING RATE OF RETURN (ARR)

- Lucy (1998) defined (ARR) as the ration of average annual profit after depreciation to capital invested. It is also know as average rate of return it tends to express the returns of a project to the cost of such a project. This the proceed of a firm are expressed as a percentage of the capital invested the acceptance rule is accepting project with highest rate of return.

ADVANTAGES OF ACCOUNTING RATE OF RETURN

- Simple to calculate and understand.
- Uses accounting data in calculation
- Considers the entire stream of incomes

DISADVANTAGE OF ARE

- Ignores the time value of money
- Not universally accepted method of calculating
- It does not consider the fact that profit can be invested.

DISCOUNTED CASH FLOW METHODS

The discounting approach tends to take cognizance of the failure of the non D.CF approach. It incorporates the timing of cash flows in its analysis. The widely accepted model of this approach are the net present value method (NPV) and the internal rate of return (IRR) method a third method, the profitability index which is a refinement of the NPV shall also be considered later.

NET PRESENT VALUE METHOD

According Bryan C (1981) defined the NPV method as a method which involves calculating the present equivalent of expected receipts and payments involved in a project and ascertaining whether in aggregate the present value of receipts outweighs the present value of payment. If there is a positive net inflow its an indication that the project should be accepted as its acceptance will not erode the value of the firm. However if there is a negative inflow (net inflow) it indicates a rejection of the project, as its acceptance will erode the value of the firm.

This process makes use of an appropriate rate of discount ( Discount rate) which ought to be equal to the opportunity cost of capital of the investing firm.

The formular for NPV is given as

NPV = __Ci __

1+v

where c = is the cash flow in the period I = 13 the period and v is the discount rate.

If the NPV is greater than zero (NPV>zero) the project should be accepted. But if the NPV is less than zero (NPV<zero) The project should be rejected. The NPV method is not affected by whether the cash inflow are uniform or not.

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