Project appraisal factors in fundamental and technical aspects of the project to determine its viability. Appraising a project enables, the project managers and organization at large to invest in projects that have considerable high returns compared to other projects that involve the same level of risk (Damodaran, 2012). In appraising the project various methods are employed, that include, net present value, discounted payback period, sensitive analysis modified the rate of return and internal rate of return (Jannasch, 2004). By calculating this figures, a project manager can be able to draw a comparative approach that will help to select and invest in the project with the highest likelihood of bringing more returns to the company (Larrabee and Voss, 2013). The ensuing segments present an analysis of tow manufacturing plants proposed by the CarMaker Ltd.
The appraisal of the two manufacturing plants for the CarMaker Ltd will be carried out using the discounted cash flow analytical techniques. This techniques factor in time value of money given that costs and benefits of the project are expected to occur in a different lifetime of the projects. The methods used are net present value, internal rate of return, accounting rate of return, and payback period.
The Two Manufacturing Plant Projects Evaluation
- Net Present Value (NPV)
Net present value discounts all the expected net benefits of the project and compares them with the initial investment costs (Periasamy, 2009). Positive NPV illustrates the ability to cover the initial investment cost (Schön, 2007). For the proposed small manufacturing plant the net present value is £ 7, 538. This shows that over the ten years the project will have more benefits than the costs. On the other hand, the net present value of the larger project for the same period is £ 20, 088. A project that has a potential of generating high NPV is considered more appropriate for the entity (McLean, 2003). As such using the NPV method, the large project would be more appealing for the company.
- Internal Rate of Return (IRR)
This is the rate at which the net present value is expected to be zero (Shim and Siegel, 2010). This is the rate of growth that a particular project is expected to generate to the company. A project is considered more profitable when its IRR exceed its cost of capital. The cost of capital for the CarMaker Company is 12%. This means that the acceptable projects by the company have to have the IRR that is greater than 12%. The IRR for the small project is 16%. This shows that undertaking this project would be for the interest of the company (Brigham and Houston, 2013). On the other hand, the IRR for the large project is 14.7%. The higher the differential rate between the IRR and the cost of cost, the higher the profitability of the project. As such, given that the small manufacturing project has a higher differential rate between the IRR and the cost of capital compared to the large project can be considered more profitable and worthy of the company.
- Accounting Rate of Return (ARR)
The accounting rate of return indicates the return or the profit that the company expects from an investment (Khan and Jain, 2007). Dividing the average profit with the initial investment made allows the company to compare profit potential for the potential projects to be undertaken (Obst, Graham, and Christie, 2007). A higher accounting rate of return is more preferable as it indicates that the project is more favorable. The smaller project has an ARR rate of 30%. This shows that the project will generate £ 0.3 more per every pound invested initially (Pandey, 2006). On the other hand, the larger project has the ARR of 31%. This shows that the larger project will more profitable per every pound invested compared to the large project. However, for the CarMaker Ltd this does not mean that the smaller manufacturing plant project is more profitable, given that the large project will lead to more sales, with low profitability level per sale.
- Payback Period
This indicates the period that will be taken before the project breaks even (Shrieve, and Wachowicz, 2001). For the smaller project, the payback period is 5.55 years. This means that it will be 5 years and about 7 months for the project to break even (Elmaghraby and Herroelen, 2010). Having a small payback period is more preferr……………………………………