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Investment appraisal issues

The basis of investment appraisal is the cost and cash flow estimates. We will now see how we can use them to come to a judgement about an investment project.

The basic requirements of investment appraisal are:

  • An estimate of what the project will cost. This is the capital investment.
  • An estimate of what the project will earn the firm. This is called the forecast of net cash inflow.

These are both estimates, and may well be inaccurate. As we have discussed, the cost estimate may to be too low (forecast is fraught with problems), so costs may well only become apparent during the project. The net cash inflow, which is based on a sales forecast for the product, will possibly be too high (marketing people are optimists and are not known for producing under-estimates). As a result, any estimate of the value of a project is likely to be too high.