Return on Investment Analysis - Essay Example

Return on Investment Analysis Name School or Institution Name 1.0 Introduction 3 2.0 Importance of accounting information systems in an organization 3 3.0 Cash flow analysis 4 4.0 Internal rate of return (IRR) 5 5.0 Net present value (NPV) 5 6.0 Profitability index 6 8.0 Conclusion and Recommendation 6 References 7 1.0 Introduction Return on investment can be described as the value which a given investment can generate over a given time (Frost et al., 2015). ROI can be calculated both qualitatively and quantitatively. It is the ratio between the company net benefit and the cost of investment. Rackley (2015) defines ROI as the measure that investigates the amount of additional profits that is produced from the investments. Usually, businesses use this calculation to compare and contrast the viability of different investments viability. The general formula for calculating return on investment is given by:- It is normally given in terms of percentage. This paper investigate the feasibility of the investment carried out by the Francisco international Airport in which they announced a 6 years plan of investing $ 383 million to renovate and reopen Terminal 2. They intend to purchase a one-time software and evaluate if it will be cost effective. 2.0 Importance of accounting information systems in an organization Every company intends to gain a competitive advantage over its competitor. Ismail & King (2014) defines a competitive advantage as a product or service that a company customers value highly than other similar firms offering the same service or goods. It is what one firm offers which other competitors do not have to offer to their customers. Information systems give organization a competitive advantage in that it is a cost leader. The firm can use information system to help in shifting the cost of doing business. It can help in reducing the cost of business processes and lower the cost of customer and suppliers hence in terms of competitive advantage; information system can be a cost leader. Information system brings in differentiation in business operations. The organizations are able to develop differential characteristics and help in reducing competitors differential advantages. This will help in adding value to the company. 3.0 Cash flow analysis The table below shows cash flow and outflow analysis Table 1.0. Cash flow analysis 2008 2009 2010 2011 2012 2013 Total Cash Outflows for Purchase $ (383,000,000) $ - $ - $ - $ - $ - Total Savings from Purchase $ 250,000 $ 44,171,412 $ 84,623,341 $ 165,435,591 $ 205,556,705 $ 5,979,593 Net Cash Flow from Purchase $ (382,750,000) $ 44,171,412 $ 84,623,341 $ 165,435,591 $ 205,556,705 $ 5,979,593 Discounted Cash Flow from purchase $ (382,750,000) $ 42,068,011 $ 80,593,658 $ 165,435,591 $ 169,112,010 $ 4,685,168 From the cash flow analysis, it shows the overall cash outflow and cash inflow from the business. The table further shows discounted cash flow to indicate the present value of the cash inflow and cash out flow. The overall cash inflow and outflow is $ 79,144,438 indicating that the overall cash inflow is more than the overall cash outflow indicating positive inflow of the net project value. In evaluating the return on investment, the overall cash inflow and outflow does not give true picture on the actual viability of the investment. Therefore, we are going to use other valuation methods like internal rate of return (IRR), Net present value and profitability index. 4.0 Internal rate of return (IRR) This investment by FS involve capital budgeting with huge initial investment. The IRR shows the percentage of the return which the company is expecting from the investment. This is normally being compared with the cost of capital. From our analysis, the cost of capital is 5% while the calculated IRR from the excel gives 6% meaning that internal rate of return in more than cost of capital by 1%. Using the decision rules for IRR, always take project when IRR is greater than cost of capital. Therefore, 6% > 5% hence the company should go ahead by buying this kind of information system since they will be able to recoup 1% more on the money they will invest in. 5.0 Net present value (NPV) It is important to focus on the overall welfare gain of the project and in this case, net present value will give a clearer picture of the viability of the project. NPV helps in measuring the absolute welfare over the whole life of the project. It is calculated by discounting the future cash flow at the cost of capital rate (r). Since here there is only one project, we will use simple NPV decision rules that is we undertake the project when NPV is positive. From the calculation, the NPV of this project is $ 45,805,114, hence the project should be undertaken. 6.0 Profitability index Some people called it the profit investment ratio (PIR) and it is the ratio of the investment payoff which the company intends to invest in. This is very important more specially in ranking different project. It is given by:- Profitability Index =  Present Value of Future Cash Flows Initial Investment Required   Hence one needs to calculate the present and divide it with the initial investment. The PI is 1.321 Using the decision rule which states that accept the project when the PI is greater than 1 hence 1.321>1 leading to the acceptance of this project. 8.0 Conclusion and Recommendation From the analysis of the project, we can conclude that the project is viable and the company should consider investing in it. In terms of return, the project has higher internal rate of return which is also positive. The IRR is greater than the cost of capital indicating that even if the company borrowed money to invest in this project, it will be able to return its loan and further have profit. The net present value is positive indicating still that the project is viable investing in and the company will get good return in it. Profitability index is just but an extension of the net present value and it gives value which is greater than 1 hence further indicating the viability of investing in this project. It is therefore recommended for the company to undertake project due to enormous benefits it comes with. There are also other benefits which this project will come with apart from the monetary gain from the project itself. References Frost, J. J., Sonfield, A., Zolna, M. R., & Finer, L. B. (2014). Return on investment: a fuller assessment of the benefits and cost savings of the US publicly funded family planning program. Milbank Quarterly, 92(4), 696-749. Ismail, N. A., & King, M. (2014). Factors influencing the alignment of accounting information systems in small and medium sized Malaysian manufacturing firms. Journal of Information Systems and Small Business, 1(1-2), 1-20. Rackley, J. (2015). Return on Investment. In Marketing Analytics Roadmap (pp. 71-85). Apress. Read More