3.3.2 Investment Appraisal (1/3)

Question 1

Investment

Answer 1

When a business sacrifices current resources (assets) in order to enjoy a stream of benefits in the future in the form of increased revenues or cash inflows.

-It is the expenditure today to generate gains in the future

Question 2

What do firms usually invest in?

Answer 2

Capital goods

Marketing

Question 3

Capital goods

Answer 3

resources that are used in the production process for other goods

Question 4

Investment appraisal

Answer 4

The evaluation of an investment project to determine whether or not it is likely to be worthwhile.

Question 5

Investment appraisal allows a business to what?

Answer 5

Make comparisons between different projects

Question 6

There are several what?

Answer 6

Quantitative methods that a business might use when evaluating a project.

Question 7

What do those quantitative methods all involve

Answer 7

All involve comparing the capital cost of the project with the net cash flow

Question 8

Capital cost

Answer 8

Fixed, one-time expenses incurred when setting up a new venture

Question 9

Venture

Answer 9

A new business or business activity that can be seen as risky.

Question 10

Net cash flow

Answer 10

the difference between a companies cash inflows and outflows within a given time period.

Question 11

What are the 3 quantitive methods that a business uses when evaluating a project

Answer 11

1) - Simple payback
2) Average rate of return AKA Accounting rate of return (ARR)
3) Discounted Cash flow

Question 12

Payback period

Answer 12

Refers to the amount of time it takes for a project to recover or pay back it’s initial investment

Question 13

When choosing between project what do you look at when using the payback method?

Answer 13

The project with the shortest payback period.

Question 14

Whats the calculation to find the remaining months in payback period method?

Answer 14

          Net cash flow in next year

Question 15

Calculating payback period through net cash flow method steps

Answer 15

1) Add up net cash flows after yr 0 to reach the initial investment
2) If there is money required to reach initial investment price then you do

      Net cash flow in next year 

3) X answer by 12

Question 16

advantages of payback period

6

Answer 16

1) Simple and easy to calculate + easy to understand results

2) Can help business in terms of cash flow:
if cash is scarce by using payback period it will show you quickest route to get initial investment back

3) Reinvest earnings faster- Allows a business to keep reinvesting + growing
4) Can tip scale for a difficult decision-PP shows exactly which investment is going to be better based on ROI, which should make decision easier

5) Keeps financial liquidity
- Business can get in trouble if have too much capital tied up in capital
- Payback period helps with liquidity as it tells you the fastest + right investment to focus on which will allow you to recoup quickly meaning you having sufficient liquid resources

6) Emphasises speed of return- maybe appropriate for businesses subject to significant market change

Question 17

Disadvantages of payback period

4

Answer 17

1) Doesn’t look at overall project return-ignores cash flows which arise after the payback has been reached
2) Encourages short term focused budgets + thinking - Not always going to be about how fast you can get your money back

3) Ignore “time value for money”
- money you invest in 10 years ago is not going to be worth the same amount today.

4)Ignores qualitative aspects of a decision