Sainsbury, one of the most successful UK businesses has attracted a lot of attention on how they use investment appraisal techniques to evaluate any proposed capital expenditure. Sainsbury capital expenditure s are motivated by three motives, to increase capacity, to replace worn out capital equipments, or to improve operational efficiency and reduce costs (Azeez 2015). Azeez (2015) notes that Sainsbury highlighted some of the capital expenditure plans in their 2013 annual report to include building 14 new supermarkets and 87 convenient stores, acquiring 50% of Lloyds Banking Group, developing alternative channels and services, creating property value, and 8 extensions to its estate.
Legal rate is the highest interest rate that a lender can charge on a loan. While conducting investment appraisal the relevant discount rate would be the actual interest rate being charged on the loan. However, we can use the legal rate when conducting a sensitivity analysis on the project to a change in interest rate. Using the legal rate would establish the percentage change in the project’s NPV in case the lender decides to alter the interest charged to the legal maximum. The legal rate can be used to compare with the project IRR in order to make a decision whether the project would be worthwhile in the event there is a rise in interest rates.
Payback period is the length of time it takes a company to recoup its initial investment. Payback has a bias towards liquidity over profitability because payback period prefers projects with shorter payback period and ignores cash flows after the payback period. Therefore, payback does not maximize the wealth of shareholders (Petty, Titman & Keown 2011). When using NPV to appraise a project, we can still accept a project with a zero NPV because of other nonfinancial considerations such as environmental factors, legal factors, or operational considerations such as an improvement in the production process (Petty, Titman & Keown 2011)
Reference List
Azeez, W., 2015. Capital Investment Appraisal in Retail Business Management: Sainsbury’s as
A Case Study. IOSR Journal of Business and Management [Online], 17(7). Available from: http://iosrjournals.org/iosr-jbm/papers/vol17-issue7/version-1/l01771104109.pdf [Accessed December 2016].
Petty, J.W., Titman, S. & Keown, A.J., 2011. Financial Management: Principles and
Applications, Melbourne: Pearson
