The detailed calculations have been shown in the annexure enclosed. It is important to understand here is that certain factors that have been provided have been considered in the calculations associated with the investment appraisal that has to be performed. However another assumption that has been made is that the sales are generated at the end of the year whereas the investment is done at the start of the year. So the investment has been considered in year 0 whereas the start of the sales is considered in year 1 onwards. Accordingly the cash flow has been discounted.
Based on the above values it can be said that strategy 2 is a better option as the NPV is higher, it has higher IRR and ARR values. Thus with respect to all the investment appraisal techniques the strategy must be employed by the company. If the cost of the market research agency is considered the NPV of strategy 1 will become negative.
The three investment appraisal techniques have been employed by the company. The value created by the investment in case of NPV method is based on the discounted cash flow. It is important to understand here that although the cash flow may be lower than other investment option, the NPV may be higher due to high cash flow in later years. For example the cash flow in case of strategy 2 may be lower due to lower selling price but since the growth in sales volume will result in higher cash flows (Zvarok, 2007). NPV thus provide comprehensive insight into the profitability made. The various factors having an impact on the cash flow that is generated such as number of years the investment will be operational, cash flows in different years and the cost of capital can be accommodated in the discount rate.
The other investment appraisal technique is annual rate of return which is based on the expected accounting profit and the average investment that is made in the project. The annual rate of return is calculated as average accounting profit made divided by average investment in the project. The average accounting profit is the profit made for over the investment period divided by number of years. Similarly average investment is calculated. In a way accounting rate of return is similar to the return on capital employed or the return on the equity. The advantage of the accounting rate of return is the simplicity and the ability to understand the investment appraisal and it provides the appraisal on the profit based on the investment and the capital employed which is the main point associated with the investment (Brush, 2004).