3.3 Flashcards
investment
- purchase of capital goods
- expenditure by a business that is likely to yield a return in the future
investment appraisal
- describes how a business might evaluate an investment project to determine if it is likely to be profitable
- allows businesses to compare investment projects
- involve the use of capital cost and net cashflow
methods of investment appraisal
- payback period (time)
- average rate of return (%)
- discounted cash flow (£)
payback period
time it takes for a project to repay its initial investment
benefits of using payback period
- simple and easy to calculate
- focuses on cash flows
- emphasises speed of return
- straightforward to compare competing projects
drawbacks of using payback period
- ignores cash flows after payback is reached
- takes no account of the ‘time value of money’
- may encourage short term thinking
- ignores qualitative aspects of a decision
- doesn’t create a decision for the investment
average rate of return (ARR)
- annual percentage return on an investment project based on average returns earned by the project
- calculation (%) = net return per annum / capital outlay (cost) x 100
benefits of using average rate of return (ARR)
- simple to understand
- easy to calculate
- focuses on overall profitability of an investment project
- easy to compare with other key target rates of return
- uses all the returns generated by a project
drawbacks of using average rate of return (ARR)
- ignores the timing of returns
- focuses on profits instead of cashflows
- doesn’t adjust for the time-value of money
critcial path analysis (CPA)
- improves the management of time and resources
- uses network diagrams
- helps a business organise its jobs and tasks, as well as planning, organising and resource management
purpose of a critical path analysis
- efficiency
- decision making
- time based management
- working capital control
network analysis
- helps a business manage projects effectively
- allows the business to find the sequence or path of tasks that are critical to the project
features of a network
- arrows and lines = tasks/activities
- tasks can be carried out together
- arrows and lines cannot cross
- each tasks takes a certain amount of time
- tasks must be completed in a certain order
- circles (nodes) = show the start and finish of a task/activity, contain information about the timing of a project
- always a node at the tart and end of a project
earliest start times (EST)
- top right of nodes
- calculated by moving left to right across the diagram
- adding up the numbers to find the largest
latest finish times (LFT)
- bottom right of nodes
- calculated by moving across the diagram right to left
- subtracting the numbers to find the smallest
critical path
- shows the tasks which, if delayed, will lead to a delay in the project
- route through the nodes should take the longest time
- shown with a line through the network
the float
- amount of time by which a task can be delayed without causing the project to be delayed
- if the number is on the critical path, float equals 0
limitations of critical path analysis
- information used to estimate times may be incorrect
- changes sometimes occur during the life of the project
- resources may be inflexible
- network analysis can become complex with hundreds of thousands of tasks to take into account
why do businesses forecast sales
- vital planning activity
- forms the basis for other parts of business planning
- helps to focus market research
extrapolation
uses trends established from historical data to forecast the future
time series data
used to identify:
- trends
- seasonal fluctuations
- cyclical fluctuations
- random fluctuations
moving avergage
- takes a data series and ‘smoothes’ the fluctuations in data to show an average
- aim is to take out extremes of data from period to period
variation formula
actual sales - trend
benefits of extrapolation
- simple method of forecasting
– not much data required - quick and cheap
drawbacks of extrapolation
- unreliable if here are fluctuations
- assumes past trends will continue
- ignores qualitative factors
sales forecasts will be more reliable if
- forecasted for a short period of time
- revised frequently
- market is slow to change
- market research data is available
- people preparing the data understand it
