Investment appraisal

Investment appraisal: definition, procedure and meaning

Investment appraisal is a central tool in operational controlling that enables companies to analyze and evaluate investment projects. Using various methods, the profitability of an investment is determined in order to create a well-founded basis for decision-making. As a result, companies can ensure that investments are profitable and successful in the long term.

What does investment mean?

Investments involve long-term capital commitment in assets such as machinery, buildings or intangible assets (e.g. patents). These investments are crucial for a company's growth and competitiveness. As they involve high costs and risks, careful evaluation is essential. This is exactly where investment accounting comes in: It checks whether an investment is economically worthwhile and what long-term returns it can generate.

Investment appraisal procedures

There are two main groups of investment appraisal methods: static and dynamic methods. Each method offers different perspectives and is suitable for different scenarios.

Static methods

Static methods look at the profitability of an investment over a short period of time without taking into account the current value of the money.

• Cost comparison calculation: Compares the costs of various investment alternatives. The option with the lowest cost is preferred.
• Profit comparison calculation: Determine the expected profit and compare various alternatives. The most profitable option is chosen.
• Amortization statement: Calculates the time required to cover initial investment costs. The shorter the payback period, the more profitable the investment.
• Static profitability calculation: Determine the ratio of profit to investment costs to determine profitability.

Dynamic processes

Dynamic methods take into account the current value of money and are therefore more accurate when evaluating long-term investments.

• Net present value method: Discounts future cash flows to the present day. The investment with the highest capital value is preferred.
• Internal rate of return method: Determines the interest rate at which the net present value of an investment is equal to zero. A higher internal return indicates a beneficial investment.
• Annuity method: Divides the net present value of an investment into equal annual payments. The investment with the highest annuity is preferred.
• Dynamic amortization calculation: Determines the time required to cover investment costs through discounted cash flows.

Functions of investment appraisal

Investment accounting is used to support investment decisions and to align them with the achievement of monetary corporate goals. It condenses the cash flows generated through investments into key figures such as profitability in order to assess the profitability of the projects. It also makes it possible to determine the absolute and relative profitability of investments in order to make the best possible decisions with limited resources.

Examples of investment calculations

• Example 1: A manufacturing company is planning to purchase a new machine. There are two models to choose from: Model A costs 80,000 euros and has an expected lifespan of 7 years, while Model B costs 90,000 euros and offers a lifespan of 10 years. The annual revenue surpluses for Model A are consistently 20,000 euros and for Model B 22,000 euros in the first year, then increase by 1,000 euros annually until the fifth year and remain constant thereafter. Using the dynamic amortization calculation, it is determined that model B represents the better investment despite higher acquisition costs due to increasing income surpluses.
• Example 2: A company is considering investing in a solar system for the company roof. The plant costs 100,000 euros and has a lifespan of 20 years. Electricity cost savings of 8,000 euros are expected annually. In addition, a government subsidy of 15,000 euros is granted. The net present value method shows that the investment is amortized after 12 years and achieves a positive net present value over the entire term.

Significance for company success

The investment appraisal is essential for the long-term success of a company. It helps to make investment decisions on a solid basis and to avoid wrong decisions. By systematically evaluating economic efficiency, a company can ensure that it uses its capital efficiently, strengthens its competitiveness and promotes sustainable growth. Dynamic processes in particular offer more precise statements and are essential for long-term projects.

conclusion

Investment appraisal is an indispensable tool for checking the profitability of investments and making well-founded decisions. By using static and dynamic methods, companies can optimally evaluate their investments and thus ensure their long-term success. Dynamic methods in particular offer a more precise perspective, as they take into account the current value of money and thus provide a better basis for strategic investments.