Risk adjusted discount rate Essay Example | Topics and Well Written Essays - 2000 words

Risk adjusted discount rate - Essay Example When considering a business investment of large sums of money within a long term project, it is an important objective to ensure that the money received over the life of the project is higher that the initial cost of investment. In deciding on the investment to undertake time is the most essential factor, followed by the amount of cash going in and out of the business. In some cases, an investment is made not to generate more cash but to make a saving on present cost. (Tony D. and Brian P. 2002, pg 458).The lay out of investments usually involve the injection of large sums of money and returns on the investment are received in a series of small amounts over an extended period of time. In addition, because large sums of money are usually involved it can be very expensive and catastrophic to pull out. Considering the loss of production and investment that can be lost from a failed investment, it is essential that investment proposals are properly screened and examined to ensure that the business uses the appropriate appraisal method. Businesses need finance or funds, both in the short-term and long-term to expand, operate their business or just survive. The business is involved in a continuous in and out flow of money by way of income and expenditure. Expenditure can either be capital expenditure, which is the payment made to acquire additional fixed assets and these fixed assets can in turn be loans made by the business or shares in another business bought by the company, as well as buildings and machinery which are usually long term. On the other hand, income can be revenue expenditures which relates to the purchase of goods and services are in use or have already been used in daily running of the business. In financing an investment a company can either use internal or external source of finance, related to the period repayment. Internal sources of finance as a long term approach are retaining profits from previous investment rather than issuing out new shares and re-investing the profit. The short term source of finance can be to increase level of creditors and reducing the stock and debtor levels. External sources of finance in the short-tem funding are short-term debts which are elements of overdrafts, loans, leases that are payable within one year and invoice discounting. Other sources of external finance are long-term which include ordinary shares or equity shares, preference shares, debentures and leases. INVESTMENT APPRAISAL ANALYSIS Capital investment appraisal methods are divided into two: firstly, those which do not take into account the time value of money and lastly, those which take into account the time value of money. METHODS WHICH DO NOT TAKE INTO ACCOUNT THE TIME VALUE OF MONEY Accounting Rate of Return (ARR) ARR is concerned with either the profit before interest and ta