Investment Appraisal Decision Making
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Published: Fri, 15 Dec 2017
The research is undertaken in the partial fulfillment of degree of MBA. The dissertation focuses on the investment appraisal in the Indian hotel industry. Shareholders and Creditors invest capital in an enterprise in the hope of gaining a return. For loan creditors they require interest plus a return of their capital, while shareholders require dividends and maintenance or increase of share prices. The capital invested is channeled through the enterprise and invested in capital projects, which must generate returns commensurate with the expectations of the providers of that capital. Capital investment within any organization is crucial and important for the organization’s well being and long time survival. Capital investments are those which have long-term effects on the organization by providing benefits over a number of years. This dissertation also shows the different types of investment appraisal and shows the company where to invest and where to not invest. Questionnaire is designed to collect primary data along with secondary data collected during literature review. Conclusions will be based on the basis of data collected from questionnaires. Secondary data and recommendations will be presented that will enhance the decision making process made in the Indian hotel industry by the investment appraisal methods.
2. OVERVIEW OF INVESTMENT APPRAISAL
Capital expenditure decisions are crucial to the long-term viability, success and survival of a company. Capital investment appraisal provides a framework in which capital projects can be considered, screened and evaluated. Because of the inflexible nature of capital projects, risk and uncertainty, and environmental change, e.g.; the tax factor, changes in government policy and technological change, it is essential that they are carefully selected, to ensure that they will help the organization to achieve its objectives. Therefore, Investment decision is one of the key decision areas of financial management.
An investment decision can be defined as one that involves the firm making a cash outlay with the aim of receiving, in return, future cash inflows. Decisions about buying a new machine, building a factory, extending warehouse, improving a delivery service, instituting a staff training scheme or launching a new product line are all examples of investment decisions that need to be made by the industry. In order to make such decisions and to ensure that they are consistent with each other, a common method of appraisal is required which can be applied equally to the whole spectrum of investment decisions and which should help to decide whether any particular investment will assist the company in maximizing shareholder wealth. Therefore, investment appraisal methods cannot replace managerial judgement, but they helps to make that judgement more sound. Investment appraisal is also referred to as ‘capital budgeting’ (Lumby. S, 1988).
The decision making consists of different stages:
- Identifying the alternatives to be considered and their transformation into workable proposals.
- Appraising the alternatives and selecting the best one with regard to the organ isation’s goals.
- Implementing the decision.
- Reviewing the selected investment project (Röhrich. M, 2007).
3. RESEARCH AIMS & OBJECTIVES
Every organization has problems in its investment areas, so an appropriate investment appraisal is required to solve these problems.The role of investment appraisal is to ensure that appropriate information is gathered relating to the investment alternatives. Capital investment decisions allocates resources within the organization to offer the best potential of meeting its objectives. It maintains and improves profit performance and increase market share. It achieves a balanced product portfolio. Investment appraisal methods are relevant to all decisions that form part of the investment planning process. Understanding different investment appraisal methods, their assumptions, limitations and possible usages will lead to an increased understanding of different decision making and an informed choice of methods. This should greatly enhance decision making in regard to both single investment projects and investment programmes. It enhances various alternatives to use different methods of investment appraisal to make business decisions. It also develops higher order skills through having to consider other factors, apart from quantitative methods, that a business might have to consider in making business decisions. The main goal of long term decision making is that the firm must handle the investment in order to earn profits greater than the funds committed. In order to handle these decisions, firms must have to make an assessment of the size of the outflows and inflows of funds, the lifespan of the investment, the degree of risk attached and the cost of obtaining funds. The main focus of this research is to analyze the decision making process made in the Indian hotel industry by the investment appraisal methods. Taj Residency Plc, Abad Plaza Plc are the hotels in India which are included in this research. This dissertation will try to answer following questions using investment appraisal methods depending on problems identified during the analysis and searching for alternatives. Key considerations in making investment decisions are:
- Should an investment be undertaken or rejected?
- In the case of mutually exclusive investment projects, which one should be preferred?
- For how long should n investment project should be utilized?
- When should the investment project be started?
- What is the scale of the investment – can the company afford it?
- How long will it be before the investment starts to yield returns?
- Which of the investment projects should be preferred and carried out when limited financial budget restricts the number that can be undertaken t the same time?
- How long will it take to pay back the investment?
- What are the expected profits from the investment?
- Could the money that is being ploughed into the investment yield higher returns elsewhere?
- Does the proposed investment fit in with the organization’s strategic objectives?
- What are previous proposals to see which techniques the organization uses?
- How the organization allows for risk and inflation in investment proposals?
- Which investment appraisal techniques would the companies wish to consider for making long term investment decision?
Investment appraisal in the Indian Hotel Industry
Hotel Industry in India has made tremendous boom in the recent years. Hotel Industry is inextricably linked to the tourism industry and the growth in the Indian tourism industry has fuelled the growth of Indian hotel industry. The hotel industry and tourism industry in India are straightly linked to each other.
Revenues of Hotel and Restaurant (H&R) industry in India during the financial year 2006-07 was INR604.32 billion , a growth of 21.27% over the previous year, primarily driven by foreign tourist arrivals ,which increased by 14.17%. at present, there are 1,980 hotels approved and classified by the Ministry of Tourism, Government of India, with a total capacity of about 110,000 hotel rooms. The tourism industry is showing excellent performance, in terms of foreign tourists arrival. It is estimated that over the next two years 70,000-80,000 rooms will be added across different categories throughout the country.
The thriving economy and increased business opportunities in India have acted as a boon for Indian hotel industry. The cheaper airlines rates to India has also made growth in the domestic and international tourists which helped the industry very successfully. In recent years the Indian government has taken several measures to boost travel & tourism which have benefited hotel industry in India.Investments in tourism infrastructure are essential for Indian hotel industry to achieve its potential. But instead there are few challenges faced by the Indian Hotel industry. They are lack of cost structure, shortage of efficient manpower, shortage of resources etc, so an appropriate investment appraisal is required to select and monitor the investments properly. The hotels which are included in this research are Taj Residency Plc, Abad Plaza Plc.
Taj Residency Plc is a five star hotel which is situated in Cochin, kerala, India. It’s a hotel which consists of 108 rooms including 12 spacious suites. The hotel provides all the services for the customers. The hotel is situated near to the sea, so it focuses mainly on international tourists. The Taj Residency Group is focusing on building a new hotel under the same name in another place in kerala, India.
Abad Plaza Plc is a five star hotel which is situated in Cochin, kerala, India. It’s a hotel which consists of 80 fully furnished luxury rooms. The hotel provides much more quality services for the satisfaction of customers. Warmth and hospitality has always been the strong points of this hotel. It is located near to the railway station and close to bus station as well. The hotel is trying to expand the business by way of building another hotel in another city in kerala, India and they are planning to extend the existing hotel into more bigger one in order to build more rooms and provide more service facilities to customers. So, a good decision must be made by using efficient investment appraisal techniques in order to invest in the right place and in the right time.
4. LITERATURE REVIEW OF INVESTMENT APPRAISAL
An investment is ‘any course of action that involves sacrifices now or in the near future in anticipation of higher future benefits’ (Pike and Neale, 2003).
Investment appraisal is influenced by the fact that external shareholders and potential investors have access to accounting data and make their estimates of firm’s economic rte of return with accrual-based accounting numbers. As a result, there is a continuing history of research analysing and relating accounting rate of return and economic rate of return concepts. Accounting information affects investment appraisal in many ways (Danielson & Press, 2003).
There are four basic techniques for the appraisal of capital investments which are :
Payback (PB) measures the time that it will take to recover the total funds invested in an project. It shows the time required for the total cash inflows to equal the total cash outflows.
A Project is considered attractive if it has short payback period. Projects with short payback periods allows managers to recuperate their investment quickly and give them more flexibility to reinvest these funds in future. They also have fewer risks than projects with longer payback periods. The payback period is popular method to evaluate capital investments. The shorter the payback period is, the more desirable the investment. Because the payback period focuses on short-term results, it does not require managers to predict cash flows far out into the future.
Accounting rate of return (ARR) measures the percentage return the project achieves over its life in terms of profitability. Accounting rate of return is often used internally when selecting projects. It measures the performance of projects and subsidiaries within an organization. ARR is almost similar to payback period method but the important difference is that it tends to favor higher risk decisions, whereas use of the payback period leads to overly conservative decisions(Broadbent. M, Cullen. J, 2003).
Internal rate of return (IRR) measures the percentage return the project achieves over its lifetime in discounted cash flows. The advantage of using IRR method is that it does not consider the time value of money and therefore is more exact and realistic than the ARR method. The shortcomings of this method are that it is time consuming to compute (Shim. K. J, 2000).
Net present value (NPV) compares the initial cost of the project with the future discounted cash flows it generates. It allows the company to screen the company projects potential profitability by discounting future cash flow expectations and comparing the sum of these cash flows to the initial capital expenditure required to fund the project. Though similar to IRR method, NPV does not calculate an investments exact rate of return but instead calculates the exact dollar amount that an investment exceeds, or fails to meet , the expected rate of return. NPV provides an excellent decision criterion for investments. NPV does not suffer from any of the drawbacks of the payback or IRR methods. NPV is the method most recommended by financial experts for making investment decisions. IRR is still used to determine the exact rate of return for an investment, but NPV has none of the problems that IRR have with unusual investments (McAllister. E. W, 2005).
5. RESEARCH METHODOLOGY
A research design provides a framework for the collection and analysis of data (Bryman and Bell, 2007). Data is divided into four types; secondary, primary, quantitative and qualitative. Selection of data type depends largely on the type of research (Buckley, 1995). The research objectives justify that descriptive research is the best method to achieve research objectives. The methods used in this research to collect primary data are as follows:
It is a commonly used technique in quantitative research methods. The main benefit of using questionnaire to collect primary data is that it collects data in a format that is easy to analyze. The questions to be asked in the questionnaire are dictated by the research objectives. Questionnaire provides good sampling control and flexibility and control with regards to location and time. It is time consuming if several segments are involved. The research undertaken will use questionnaire to collect primary data. The mainrationale behind choosing questionnaire is that the research requires the controlled responses from the individuals. Time limitation for the dissertation also supports the selection of questionnaire for primary data collection as it is less time consuming to conduct.
A Personal interview is defined as a purposeful discussion between two or more people (Kahn and Cannell, 1957). The data collected using personal interview is very reliable. Interviews can be un-structured or structured (Saunders et al, 2007). Structured interviews are a systematic goal oriented process. They force organized communication between the knowledge engineer and the expert. A structured interview is a question and answer session, which is recorded in some way. Personal interviews provide the visual verification of respondents characteristics and references to sources can be used to verify facts. However, personal interviews may be expensive and difficult to arrange. Also respondents may formulate the answers depending upon their profiles.
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