Page 7 - CIMA MCS Workbook May 2019 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

management team who can check whether the potential projects tie into the objectives set in the
first stage.

The third stage is to identify the states of nature. This means that the company should try to
gather as much data as possible about areas that could affect the company and the project over
the life of the project and beyond. It will involve trying to predict the direction of the economy
(both in Corvola and any countries where the projects would take place), including predictions for
interest rates, tax rates and inflation rates, all of which will affect the investment appraisals. It
will look at trends within the housing industry, which may affect the scale of the investment, and
trends in manufacturing processes.

This stage may involve the marketing and finance teams and the utilisation of resources outside of
the company – perhaps using a market research agency to gather the data.

Decision phase. This phase involves listing possible outcomes, measuring payoffs and selecting
investment projects to go ahead with. It is the investment appraisal part of the process.

An investment appraisal itself involves predicting future relevant cash flows for the various
potential projects, discounting them at an appropriate cost of capital and comparing the net
present values of each project against each other.
Utilising all of the information gathered in the creation stage, an investment appraisal will be
produced for each potential project

Differing projects will have different lifespans, different levels of capital investment and different
potential for flexibility. It may be that some projects can be started off small but with the
potential to grow if they are initially successful. These projects may be more attractive than ones
that require a significantly larger initial capital investment.

Any negative NPV projects will be rejected and the remaining positive NPV projects considered.

In theory the project with the highest positive NPV should be chosen, but there may be other
factors to be considered, such as the effect on the current workforce or the potential to curtail or
expand the size of the project as needed given the anticipated market conditions.

The team involved in evaluating the investment appraisals should include an accountant to double
check the numbers and calculations, along with people who are familiar with the detail of the
project operations and the various likely cash flows that will be seen. It is likely that a large cross‐
section of the business managers would be able to give their input.

NPV calculations are not the only investment appraisal techniques that can be used. For instance,
if the company is reluctant to tie up large amounts of cash for too long, it may consider also using
payback as an appraisal tool.

Implementation phase.

The first stage of the implementation phase is to get sign off from senior management for the
chosen projects. This is the stage at which the large capital investment is committed, so should
be treated with due consideration. A capital expenditure committee may be put in place whose
purpose is to review and critique the proposals before sign off, with the objectives of the
company always in mind. The committee could be made up of people from key stakeholders
within the business.

Once the project is implemented, this should not be the end of the process. It’s important that
businesses review the large investments that they have taken on to see if they did indeed make

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