Investment Appraisal (or Capital Budgeting) is the decision making process for investing in long-term assets The Investment Appraisal is to determine and evaluate potential expenses or investments that are significant in amount. It is usually involving the calculation of each project's or asset’s future profit by period, the present value (PV) of the cash flows, pay back the initial cash investment, an assessment of risk, and other factors. The formal method of Investment Appraisal techniques: Net Present Value (NPV); Internal Rate of Return (IRR); Profitability Index (PI); Payback Period, etc.
Capital Budgeting refers to the Investment Appraisal. The Capital Budgeting is to budget for major capital investments or expenditures.
Net Present Value (NPV) is the present value of an investment's expected cash inflows minus the costs of acquiring the investment. The formula for NPV = (Cash inflows from investment) – (cash outflows or costs of investment)
Internal Rate of Return (IRR) is a rate of return used in the capital budgeting to measure and compare the profitability of investments.
Profitability Index (PI) is the investment appraisal technique measures a ratio between the present value of future cash flows and the present value of costs for the project.
Payback Period is the investment appraisal technique to evaluate the period of time required for the return on an investment.
Return On Investment (ROI) is the profitability measure that evaluates the performance of a business by dividing net profit by net worth.
Discount Rate is 1) the reduced price that is offered to customers if they buy large quantities of products or services; 2) the rate of interest that a country's central bank charges for lending money to other banks; 3) the interest rate used to discount a stream of future cash flows to its present value. The Discount Rate often used in capital budgeting that makes the net present value (NPV) of all cash flows from a particular project equal to zero. Generally, the higher the internal rate of return (IRR) is more desirable for the capital budgeting review.
Discounted Cash Flow (DCF) analysis is the method of valuing a project using the concepts of the time value of money. The DCF analysis is to determine the present value of future cash flows (future free cash flow projection and discount it). All future cash flow is estimated and discounted by using cost of capital to give its present value. If the DCF analysis value comes higher than the current cost of the investment, the opportunity is a positive.
Discount Factor is the percentage rate required to calculate the present value (PV) of a future cash flow. The Discount Factor (Df) Formula: 1/(1+r)^n where, r = interest or discount rate or rate of return, n = time periods.
B. Input Information
Total Investment Cost (TIC) consists of capital cost (EPC cost), working capital, and owner’s costs includes land, financial cost, and operational costs, etc.
Working Capital: A Capital Cost is a cost associated with constructing the facility includes the direct costs of building the facility as well as the indirect costs. The Capital Cost does not include owner's production costs such as feed stock, operating utilities, and operations staff.
Owner’s Costs includes a land, project financial cost (funding cost), owner’s third party cost including engineering studies, permit related works, etc., licensing fees, training, and owner corporate costs etc.
1. Tax Rate: A Tax is a compulsory monetary contribution to the government that is based on an income, business profit, occupation, privilege, property, added to the cost of goods or services, etc.
2. Depreciation Terms (years, model, salvage value): A Depreciation is the assigning or allocating the cost of a tangible asset over the accounting periods that the asset is likely to be used.
3. Depreciation Model is the formula that use to calculate depreciation of assets. The Depreciation Models are: 1) Straight Line Depreciation model is to assume that the asset decreases by a fixed amount every year until the asset reaches its salvage value. 2) Exponential depreciation (or Accelerated Depreciation) model is based on a fixed annual percent decrease that allows company to write off assets faster in earlier years than the Straight Line Depreciation method.
4. Salvage Value is the estimated resale value of an asset at the end of its economical or useful life.
5. Operations Period: An Operation means a state of working or being able to work, or a way or process that parts of a machine or system work together smoothly to produce goods.
6. Maintenance Cost (% of TIC): A Maintenance is the activities performed on an item to minimize the possibility of damage or the lowering of quality because of corrosion, contamination, or deterioration for the continuous operation.
7. Inflation Rate: An Inflation means a sustained increase in the aggregate or general price level in an economy that is an increase in the cost of living. The Inflation (or deflation) in the project cost is usually expressed as the annualized percentage rate of change in the construction cost indices.
8. Escalation: An Escalation is to become or make something increase in price, specially due to inflation or become greater or more serious.
9. Insurance Cost: An Insurance is an agreement that a company or individual (Insured) buys a financial compensation of loss or damage or injury by an accident or incident risks from an insurance company (Insurer). The Insurance can be one of the risk transfer method.
10. Corporate Costs consist of labour, marketing expenses, other corporate indirect costs, etc.
C. Output Information
IRR (Internal rate of return)
NPV (Net Present Value)
ROI (Return On Investment)
Cash Flow: A Cash Flow is the difference in amount of cash available at the beginning of a period (opening balance: forecast) and the amount at the end of that period (closing balance: actual) of a business, project, or financial product. It is usually measured during a specified period of time.
Margins: A Margin is 1) a profit difference between a total sales amount from total cost including expenses. 2) the amount by which one thing is different from another or difference from the standard requirement.
Evaluation Templates and Models to be developed