project financial appraisal techniquesv

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Project Financial Appraisal Techniques- part of our advanced finance for non financial managers Course programme

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Key Objectives

What is financial evaluation

Why project financial evaluation techniques

Project financial risks assessment

Practice illustration of financial plan


Definition of financial evaluation

Concern with the assessment of financial viability of projects

Assessment of risk profile and financial efficiency


Why Project Financial Evaluation

Does the project create financial wealth

How quickly can we recover project investment

How risky is the project vis a viv it returns potentials

How much capital do we need to invest


Demand Risk

Competition Risk

Financial Risk

Operational Risk

Interest Rate Risk

Financial Risks Facing Projects


Financial Evaluation Techniques For Effective Project Management

Payback Per iod Return On Investment Prof i t Based Measure s Net Present Value Method


Payback Period Technique

Payback PeriodThis is probably the most frequently used technique for assessing the financial viability of projects. It regards projects which repay their capital cost most quickly as being the best. For example, if a cafe purchases a new cooker for £1000 and makes an average of £.50 profit on each meal, the cooker will be paid for after £1000/£0.50=2000 meals. If the cafe sells 40 meals a day, the full price of the cooker is paid back after 2000/40=50days.

Attempt this question now:Frank and Mary decided to set up a carpet cleaning business. They purchased carpet cleaning equipment for £800. On average they expect to earn £5 per carpet after expenses and to be able to clean two carpets, five days a week. Calculate their payback period in weeks


Payback Period Technique

The payback period is ( £800/ £5x2x5) = £800/50=16weeks.

You will appreciate as a project manager that the calculations above are rater simplistic.

The capital cost of equipment or machinery is fairly easy to work out. It is how much the organisation paid for it together with delivery, installation and other costs incurred to get it up and running. But how is income calculated?

And you know that income does not always flow in evenly


Project Management – Revenue & Cost Projections

Project Management In Practice

Hampdene Ltd is a company specialising in arable farming. It is thinking about purchasing a combine harvester for a capital cost of £160,000 to be used from August to early October on its fields. It will also be rented out to a neighboring farm for the remainder of October. Harvest income flow in from October to December and total sales are expected to bring in £60,000 in year 1, £66,000 in year 2 and £70000 for each year from year 3 to year 8 (additional competition in world markets is faced in the later years). Running costs of the combine harvester are estimated at £4000 a year for year 1 and year 2 and £5000 for each year thereafter. Seeds fertilisers and other costs of production are generally 50 percent of sales income.

Rental income from hiring out the vehicle is estimated at £2000 per year for the foreseeable future. While not in use, storage, security and maintenance expenses of the combine harvester are estimated at £1000 per year.

Your task is to use a separate sheet and put together the projection of revenue and costs including net profit or loss for this project.


Project Management – Revenue & Cost Projections- Answer

Year 1£

Year 2£

Year 3 £

Year 4£

Year 5£

Year 6£

Year 7£

Year 8£

Income:

Crop (sales) 60000 66000 70000 70000 £70000 £70000 £70000 £70000

Rental 2000 2000 2000 2000 2000 2000 2000 2000

62000 68000 72000 72000 72000 72000 72000 72000

Outgoings

Running costs 4000 4000 5000 5000 5000 5000 5000 5000

Storage etc 1000 1000 1000 1000 1000 1000 1000 1000

Cost of production of crop

30000 33000 35000 35000 35000 35000 35000 35000

35000 38000 41000 41000 41000 41000 41000 41000

Net Income 27000 30000 31000 31000 31000 31000 31000 31000


Project Management – Pay Back Period Technique In Practice

Year Net Income£

Additional Overheads

Finalnet income

(ie Net income less additional

overheads)

Cost of combine harvester less

final net income(£160000)

Year 1 27000 8000 19000 (141000)

Year 2 30000 7000 23000 (118000)

Year 3 31000 6000 25000 (93000)

Year 4 31000 5000 26000 (67000)

Year 5 31000 5000 26000 (41000)

Year 6 31000 5000 26000 (15000)

Year 7 31000 5000 26000 11000

Year 8 31000 5000 26000 37000


Project Management –Net Present Value Technique v Time

Initial Investment£

10% Yearly Interest£

Total Money Available£

100 10 110

110 11 121

121 12 133

133 13 146

146 14 161

161 16 177


Project Management –Net Present Value Technique v Time

Year Net Income£

Additional Overheads

£

Finalnet income

(ie Net income less additional

overheads)£

Discounting Factor for 10%

Present Value of projected net

income£

Year 1 27000 8000 19000 .909 17272.73

Year 2 30000 7000 23000 .826 19008.26

Year 3 31000 6000 25000 .752 18796.99

Year 4 31000 5000 26000 .685 17808.22

Year 5 31000 5000 26000 .621 16149.07

Year 6 31000 5000 26000 .565 14689.27

Year 7 31000 5000 26000 .513 13333.33

Year 8 31000 5000 26000 .467 12149.53

Total Present Value of all future net income 129207.4

Present value of capital to be invested

(160000)

Net Present Value - difference between Present Value of future net income and capital to be invested

-30792.6


Conclusion – The End

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