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3.5 Analysis of capital investment Appraisal technique MOHA soft drink evaluates return on his investment by the use of the following capital investment appraisal technique.
3.5.1 Payback period The payback period is the number of years until the cumulative cash benefit equals the money invested.
MOHA soft drink industry set cutoff period for investment on Bure plant were 8 year.
Bure plant after incurring loss for three consecutive years start to generate profit and recover the initial investment cost within three year. The PBP (payback period) for this investment is six year that is less than the firm cutoff period.
3.5.2 Net present value / NPV/ The project selection method that is most consistent with the goal of owner wealth maximization is the net present value. Net present value is the difference between an investments market and its cost that we add the present value of project projected cash flows and subtract the amount of the initial investment.
MOHA soft drink assigns its required rate of return is by studying
the needs of the market,
similar industries, and competitor and by consulting the expert in the area.
Hawassa bottling plant investment was calculated the net present value by opportunity cost of capital 10.5%. The net present value shows that positive NPV that is 11,228,000
Birr at the end of the 10
th year.
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3.5.3 Internal Rate of Return (IRR) IRR is the discount rate for which the present value of the net receipts from the project is equals to the present value of the investment and the NPV is zero The procedure used to calculate the IRR is the same as the
one used to calculate the NPV, but instead of discounting cash flows at predetermined
required rate of return, several discounting rates may have to be tried until the rate is found at which the NPV is zero.
MOHA soft drink Hawassa bottling plant calculates the IRR by trial and error method. The IRR is 12.49 higher than the assumed opportunity cost of capital 10.5% that is the firms values increase because the projects estimated returns exceeds the firms required rate of return.
