3.2.2 Investment appraisal

Question 1

What can investment appraisal be applied to

Answer 1

strategic decisions

Question 2

define investment appraisal

Answer 2

process of using techniques to analyse whether an investment in a project is worthwhile

Question 3

what is the purpose in investment appraisal (4)

Answer 3

-reduces risk
-assesses potential returns of a project
-decide between 2 projects
-show to investors

Question 4

what does investment appraisal compare

Answer 4

net cashflow with initial investment

Question 5

why can it take managers weeks/ months

Answer 5

data can be difficult to find and analyse

Question 6

what are the 3 quantitative methods

Answer 6

1. payback
2. average rate of return (ARR)
3. net present value (NPV)

Question 7

what is formula for payback?

Answer 7

sum invested/ net cash per time period

Question 8

what is formula for exact payback?

Answer 8

outlay outstanding/ monthly cash in year of payback

Question 9

what is the criterion level

Answer 9

18 months

Question 10

why can the time of payback be delayed (3)

Answer 10

-production issues
-product recall
-unexpected rise in costs

Question 11

state 3 positives of payback

Answer 11

-straight forward to calculate, interpret + compare to projects
-takes timings of cashflows into account so adjustments can be made
-emphasis on speed of return - important in dynamic markets

Question 12

state 3 negatives of payback

Answer 12

-ignores what happens after payback
-ignores time value of money and life of assets
-ignores qualitative aspects of decision making

Question 13

what is the formula for ARR

Answer 13

(average annual return/ initial outlay) x100

Question 14

what does ARR compare

Answer 14

average annual profit from an investment with the money invested

Question 15

what are the 3 steps to ARR

Answer 15

1. identify lifetime profit
2. divide by number of years
3. calc. annual profit as a % of initial outlay

Question 16

what is the general rule for ARR

Answer 16

should be higher than return a business would get by investing on a bank (normally 15%)

Question 17

what are 3 positives to ARR

Answer 17

-focuses on profitability + provides % that can be compared
-uses cash flow over a lifetime of the project
-important as profitability key

Question 18

what are 3 negatives to ARR

Answer 18

-ignores value of money
-ignores the cash flow timings
-doesn’t take into account qualitative factors

Question 19

what does NPV take into account

Answer 19

time value of money using discount factors

Question 20

what are 3 positives of NPV

Answer 20

-takes time value of money into account, placing emphasis on earlier cash flows
-looks at cash flows for the full life of the project + takes inflation into account
-considers the opportunity cost of investment in a project vs putting into an account

Question 20

what are 3 negatives of NPV

Answer 20

-can be complicated method to communicate
-difficult to select most suitable discount rate - project rejected as a result?
-only comparable to projects where initial outlay is the same