An investment appraisal determines the profitability of a new investment. In many cases, a new investment has a wide range of hidden costs and points of profit beyond the bottom line figures. By using an investment appraisal, a company can look over the full range of changes brought on by a new project before it begins. This is simply a method of making better informed decisions to improve the viability of the company. Another common term for these types of appraisals is ‘capital budgeting.’
When a company undertakes a new project, it will generally have a wide range of known figures associated with it. Increases or decreases in manpower, company downtime, salaries and material costs are all very easy to see and figure out. These costs are the ones most often associated with determining a project’s future, but they are far from the only ones.
In order to find all these hidden figures, a company will use an investment appraisal. These will look at the full impact the project will have on the company to find the real cost and real profit potential. These studies will generally start with the initial facts and figures and then start moving outwards from the project. The appraisal will find and put a number to all of the current and future effects that the project will create. These numbers are often strikingly different from the basic figures.
An example of an investment appraisal is the purchase of a new piece of manufacturing equipment. The machine will replace an existing machine, perform the task in half the time and drop the number of operators from three to two; on paper, the machine seems fantastic. The appraisal will start with the cost of removing the current machine and rearranging the factory floor for the new system, the power, and the cost of retraining the two existing workers. These costs are all included right in the initial description, but they are the non-obvious underlying factors.
The appraisal will move on to other affected systems for the second part of the appraisal. For example, by examining the current system, they can find if the faster operation will create bottlenecks in other areas of production. If one machine operates faster, but only works half the time because the rest of the system can’t keep pace, it is actually not working any faster than the old system. In the end, the investment appraisal will show if the new machine is worth the cost or if keeping the older machine is better.