3.3 Investment Appraisal Flashcards
Investment Appraisal
How long a project takes to recoup it’s initial investment.
Businesses wish to analyse
How soon the investment will recoup the initial overlay.
How profitable the investment will be.
Key data which is collected
Sales forecasts
Fixed and variable costs
Pricing information
Simple payback period
Calculation of amount of time it is expected an investment will pay itself.
What’s the formula for simple payback period?
Initial outlay/ Net cash flow period
Simple payback period advantages
Simple method to calculate and understand
Particularly useful when cash flow management is vital
Simple payback period disadvantages
No insight into profitability of investments
Only consider total length of time to recover an investment
Average rate of return
looks at average rate of return and if meets target
Average rate of return formula
Average annual return/initial overlay x 100
Benefits of ARR
Considers all net cash flow generated by an investment over time.
Easy to compare percentage returns with each other.
Disadvantages of ARR
Ignores timing of cash flow
Opportunity cost of investment Is ignored
Net present value
Financial metric used to evaluate the value of an investment of a project.
What does Net present value take into account?
Effect of interest rate and time
What should be taken into account when calculating net value?
Money received in the future is worth less due to inflation.
Opportunity cost of not having money available for other uses.
What happens in net present value?
Value of all future net cash flow calculated and then discounted by the table.
What is deducted?
cost of initial investment
When is the investment worthwhile?
if future net cash flow-initial investment is positive
What are discounted cash flows calculated by?
Discount tables
Benefits of NPV
Considers opportunity cost of money.
Discount tables used to calculate forecast future values.
Disadvantages of NPV
Most complicated.
Difficult to accurately forecast future cash flow.
What are the limitations of Investment appraisal?
Relies upon forecasted cash flow.
Long term cash flow forecasts can be inaccurate.
Factors other than cost and return of investment are not considered.
Why is it a disadvantage that investment appraisal relies on forecasted cash flow?
May lack accuracy.
Why can long term cash flow forecasts be inaccurate?
Unexpected increase in costs
Arrival of new competitors
Changes in consumer trends
Which factors are not considered?
Cooperate objectives
Public relations
