Whether considering starting or acquiring a business, or contemplating an investment in a new or ongoing enterprise, you will want to inform your decision with an investment appraisal. Professional accountant Peter Plant writes that an investment appraisal "is of fundamental importance" for several reasons. The investment usually involves committing substantial resources. The decision requires an understanding of the feasibility of both strategic and tactical objectives. Understanding the relative risk depends upon an analysis of cash flows using a range of probabilities, such as different inflation rates.
A capital investment appraisal will reveal the project's general feasibility. This will include the projected cash flows and projected quarterly or annual profits. It will normally include a net present value (NPV) analysis. These will give you a good idea of the probable profitability of the project in both the near and long terms.
A proposed investment almost never exists without alternatives. When considering an investment, you need to understand how it ranks in relation to others like it. Therefore, the investment appraisal should include a review of similar available investments and a comparison between the proposed project and the alternative projects.
One critical aspect of the investment appraisal assesses capital resources. Once your analysis reveals the initial capital requirements and the additional capital contributions the project will require going forward, you need to understand and describe the available capital resources the project requires.
The investment appraisal should also describe the process required to move the project from the initial investment appraisal to its inauguration. In most cases, this will involve a description of the authorisations required. Most projects will require internal company authorisations, including in some instances the board of directors and CEO, in other instances departmental or regional agencies. Understanding these internal authorisation requirements early on becomes critically important for the project's timely development. In other cases, authorisations will include various public agencies and review boards. The investment appraisal enumerates these authorisations and estimates the approval costs. In some cases, this kind of review reveals that a project that seems otherwise feasible will cost far more than anticipated because of the difficulty and expense of obtaining necessary authorisations.
Another important function of the investment appraisal concerns uncertainty. Projecting discounted cash flows over a period of time requires assigning specific values to inflation rates, future regulatory costs and other factors that, in reality, remain uncertain. The investment appraisal includes these variables by assigning probabilities to ranges of outcomes. This analytical technique provides a realistic model that includes risk assessments.
An investment appraisal will not only demonstrate a project's relative financial feasibility, it will also assess how well the particular project fits into a company's strategic plans. Ultimately, how well a proposed project moves forward strategic objectives or how well it fits into the company's social fabric will have wider financial implications. A book publisher, for example, may have a roster of prominent authors that favour a specific part of the political spectrum. A contemplated book project may promise generous cash flows going forward, but if its political message opposes the general orientation of the company's current authors and offends them, this will weaken the bond between the company and its valuable current roster. Over the long run, the contemplated project does not fit well within this company, as the investment appraisal will point out.
- ACCA: Capital Investment Appraisal - Part 1; Peter Plant, 2000
- NGFL Wales Business Studies: Investment Appraisal
- "Harvard Business Review"; Risk Analysis in Capital Investment; David B. Hertz; 1964