Fundamentals of Investment Appraisal

2021-05-07 09:24:08
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Kyle Dier can borrow the mortgage from various lenders available in the market. There are three types of mortgages in the market he can choose depending on the kind of interest rates. They include variable rates, fixed rates and tracker mortgages. Diers choice of the best rates from the different lenders depends on the interest rates and loan-to-value (LTV). Coventry Building Society offers the best lifetime variable mortgage interest rate of 1.99 % with maximum LVT of 85 %. Woolwich offers the cheapest fixed mortgage rates at 2.89 % fixed for three years and an overall cost of 3.0%. It offers an LTV of 95 %. HSBC offers the best tracker rate that Dier can afford (Tracker mortgages, 2016). The initial rate offered is 2.19 % and LTV of 70 %.

It is recommended that Dier purchases the variable rate mortgage provided by Coventry Building Society. It has the least repayment amount and provides a favourable personal contribution towards the value of the assets making it affordable for the purchase of the two properties identified. It also does not have a penalty in case of early clearance. Though the rate is not known for the entire loan period, it is favourable since the other mortgage interests are uncertain for the 20 years. The alternative between the 250,000 and 400,000 should be selected depending on the income of Dier.

1. Economic order quantity

The board should make an order when the holding cost increase with 10 %. It produces the least EOQ in the entire economic situation. Each order should have a volume of 1355, 1545, and 1767 for the crisis, recovery and medium recovery periods respectively. If it demand was the only factor that changes it is recommended the management to make orders of 1414, 1612, and 1943 for the crisis, recovery and medium recovery periods respectively.

2. Production and marketing plan

The company should produce and market 1414 units of the basic model, 900 units of the medium model and 114 units of luxury products. The production of these combinations would maximize the profits making 838,571.43. If the demand for the medium model is change to 1000 units, the company should produce 738 units of the basic model, 1000 of the medium model and 47 units of the luxury model. The profits would increase to 845,312.50. If the hours for assembly increase to 9500, the company should produce 738 units of the basic model, 900 units of the medium model and 385 units of luxury products. The level would generate a profit of 858,846.15. It is, therefore, recommended the management to increase the assembly hours since it has the highest profits.

3. Family income

There is no evidence that the average house price is 500,000. Since the mean of the house price is 432,047.64. There is an expectation that the two variables have a relationship with the family income, and the house prices are directly related. Families with high income are expected to purchase a home with greater value and vice versa. Household income and house price are closely linked since they have a correlation of 0.98 indicating a very close relationship. The data also shows that the two variables move in the same direction since they have a positive correlation.

4. Investment appraisal methods

Investors can use appraisal methods such as payback period, internal rate of return and net present value to assess the whether to invest or not (Gotze, Northcott and Schuster, 2015). The methods can have different results and also have different ways of interpreting the results. The uses of the appraisal methods are discussed below.

The payback period indicates the time that an investor will take before they recoup back their investment. They are simple and easy to calculate. The interpretation of the payback period result is straightforward and does not require expertise to make a decision. However, the method does not consider the time value of money and may lead to a misleading conclusion when the data taken takes a long time (Isaac and O'Leary, 2012). It can also lead to the rejection of viable projects when the set payback period is too short. In the case of Make More Plc, the project should be rejected since the payback period is three years and the recommended is two years.

The net present value helps to assess the acceptability of a project by evaluating the cash flows. It considers the time value of money, and it is acceptable when it is positive (Rohrich, 2007). The appraisal method can assess many projects and help to select the best alternative. It is however not easy to determine and at times of economic crisis not easily identified because of unstable expected returns in the capital.

The internal rate of return to the point where the net present value is zero, and it is used to identify the levels at which the return on capital is expected. It considers the time value of money. Its main disadvantage is that it is hard to select the best alternative when two projects have the same internal rate of return. In the Make and More Plc, it is recommended to invest in the projects since it has a positive net present value.

References

Gotze, U., Northcott, D. and Schuster, P. (2015). Investment Appraisal. Berlin, Heidelberg: Springer Berlin Heidelberg.

Isaac, D. and O'Leary, J. (2012). Property valuation principles. Basingstoke: Palgrave Macmillan.

Rohrich, M. (2007). Fundamentals of Investment Appraisal. Munchen: De Gruyter.

Tracker mortgages. (2016). [online] money.co.uk. Available at: http://www.money.co.uk/mortgages/tracker-mortgages.htm [Accessed 6 Mar. 2016].

 

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