Accounting for Business Assignment Sample

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Accounting for Business Essay

Investment analysis may be defined as a tool which investors undertake for examining, assessing and making informed decisions in relation to the potential profitability of an investment opportunity. For students seeking help writing assignments on capital budgeting, this analysis provides essential frameworks. Investment analysis is beneficial for the investors because it facilitates optimisation of resource allocation, improves portfolio performance and manages investment risks (Olayinka, 2022). This essay depicts the role of capital budgeting tools in making evaluations of opportunities available for the investment purpose.

Average rate of return (ARR) is considered as one of the significant tool that helps the investors to make decisions in relation to investments such as acquisition of another company or sizeable business investment and purchasing of costly equipment. It is calculated by the dividing the average of annual accounting profits by the average or initial investments. This method is useful for the investors to make the decisions about investments because it is easy to calculate and understand, consider the whole life of the project and is reliable with the objective of maximising profits (Siziba and Hall, 2021). In addition, ARR is based on accounting profit which is readily accessible from the income statement. Considering this method is beneficial for the investors because it takes the profitability of the project over its whole lifespan into account. On the other hand, in some cases this method is disadvantageous for investors because it ignores the time value of money, relies on accounting methods and does not have clear rule of decision. Generally, the investment which have a higher rate is more attractive and profitable for the investors. In the given case, the ARR of proposals 1 and 2 accounts for 14% & 16%, respectively; accordingly, priority should be given to the second one as higher profitability associated with it.

Accounting for Business Assignment Sample

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Payback period may be defined as the length of time that an investor will take for recovering the amount invested at the initial level. Generally, the investments which have shorter paybacks are the most attractive, while longer payback periods are considered less desirable. Adoption of this method is beneficial for the investors because it is simple to use and easy to understand. Further, it gives more preference to the liquidity as well as provides a quick solution (Dai et al, 2022). The payback period is easy to calculate and requires fewer inputs, so investors are able to make quick and effective decisions with the limited resources. On the other hand, in many cases payback period is disadvantageous for the investors because it ignores the time value of money and ignores profitability. Along with this, an investment which has a shorter payback period is not guaranteed to be profitable. In the given case, the payback period of proposal 1 is 2.5 years and proposal 2 is 3 years. This clearly exhibits that in option 1 the investor will recoup the initial investment within the period of 2 years and 5 months and thereafter become able to generate profit.

Net present value (NPV) refers to the differences between the present value of cash inflows and outflows over a given period of time. Before making investment, it will be significant for the investors to consider its NPV because it helps in determining if it’s profitable. Usually, the investment which has higher or positive NPV means it will be profitable and vice versa. Adoption of this method is beneficial for the investors because it understands the time value for money, calculating accurate investment value and helps in making the informed decisions (Szwarcfiter and Herer, 2023). This method is considering the time value of money which represents the worth of money is today is more than in the future on same amount. On the other hand, the weaknesses of NPV are sensitive to discounting rate and dependence on assumptions. NPV is greatly impacted by the discounting rates even small modifications can make big difference in final calculations. In the given case, the NPV of proposal 1 is £280,000 and proposal 2 accounts for £320,000. It means the proposal 2 is attractive and profitable for the investors because it has higher NPV as compare to proposal 1. NPV also considers time value for money, which depicts the value of proposal 2 will increase in future which generate higher profits.

Internal rate of return (IRR) is a capital budgeting calculation for the investors in order to decide which investment is worthy for them to purchase. Adoption of this method is useful for the investors because it considers time value for money and simple as well as understands to use compared to others (Hazen and Magni, 2021). On the other hand, in some cases IRR is disadvantageous for the investors because it ignores the size of project and ignores future costs. In the given case the, IRR of project 1 is 17% and 2 is 15 it means the project 1 is generating higher rate of return and generating profits.

From the investment analysis it has been determined that proposal 2 will be more profitable and attractive for the investors over 1 because it has higher NPV and ARR. This project will prove to be more beneficial with the objective of maximising profits, as it considers the time value of money concept and clearly states the profit which the business unit will generate over the period of time. Apart from this, to make informed decisions about profitable or attractive project it is important for investors to resolve the conflict of NPV and IRR. To deal with this type of conflict, investors will need to consider value additivity principle, mutuality of projects, reinvestment rate assumptions and multiple rates of returns (Perna, 2024). Referring overall assessment, it can be stated that from the perspective of maximizing overall wealth option 2 will be more significant.

The cost of capital and net present value of the project has indirect relationships. If the cost of capital decreases then the NPV of project will be increased and vice versa. The cost of capital is used to discount the future cash flows from projects and offer opportunities in order to anticipate the NPV and capabilities to generate the value. If the cost of capital is lower than NPV, it means the project will be attractive and profitable for the investors.

In conclusion, it can be stated that capital budgeting is important for the investors before making decisions about the investments because it helps in evaluating whether project will be attractive or profitable. To measure the profitability of investment, investors can use various accounting methods such as ARR, IRR, payback period and NPV (He, Liao and Wang, 2022). From the given case it has been determined that, the project 2 will be profitable as compare to 1 because it will offer higher return in monetary terms after the specific time period.

References

Books and Journals

• Dai, H., Li, N., Wang, Y. and Zhao, X., 2022, March. The analysis of three main investment criteria: NPV IRR and payback period. In 2022 7th International Conference on Financial Innovation and Economic Development (ICFIED 2022) (pp. 185-189). Atlantis Press.
• Hazen, G. and Magni, C.A., 2021. Average internal rate of return for risky projects. The Engineering Economist, 66(2), pp.90-120.
• He, Z., Liao, G. and Wang, B., 2022. What gets measured gets managed: Investment and the cost of capital (No. w29775). National Bureau of Economic Research.
• Olayinka, A.A., 2022. Financial statement analysis as a tool for investment decisions and assessment of companies’ performance. International Journal of Financial, Accounting, and Management, 4(1), pp.49-66.
• Perna, A., 2024. Optimization of Internal Rate of Return and Net Present Value for investments (Doctoral dissertation, Politecnico di Torino).
• Siziba, S. and Hall, J.H., 2021. The evolution of the application of capital budgeting techniques in enterprises. Global finance journal, 47, p.100504.
• Szwarcfiter, C. and Herer, Y.T., 2023. Modeling and solving the tradeoff between project value and net present value. IEEE Access.