Overview

Learning objectives

After studying this chapter, you should have developed an appreciation of:

1. How the accounting rate of return, payback, net present value and internal rate of return investment appraisal techniques can be applied

2. The relative merits of these investment appraisal techniques

3. What is meant by the time value of money

4. How the present value of a cash flow occurring in the future can be determined using discounting tables.

Introduction

This topic focuses on analytical methods that can be used to assess the merit of long-term investment proposals. The process of rationing funds to long-term investment proposals is often referred to as capital budgeting . In the context of financial management, the term capital is used when referring to long-term funds (we talk of a company raising capital when it issues more equity finance or borrows long-term debt). In the earlier chapter concerned with budgeting, it was noted that the budget relates to plans for the forthcoming year. It follows that capital budgeting relates to longer-term budgeting, i.e. decision making concerned with investing in fixed assets such as laundry or kitchen equipment, or the decision to refurbish rooms. As a large proportion of a hotel s assets are fixed assets, it is evident that capital budgeting is an important decision-making area for hotel managers.

The chapter is structured around the following four investment appraisal techniques:

• Accounting rate of return

• Payback

• Net present value

• Internal rate of return.

Accounting Rate of Return

A...