3.3.2 Investment Appraisal Flashcards
What is investment appraisal?
This is where you check if something is profitable enough for a business to invest in considering things like strategic fit.
Define payback
Time it takes for a project to repay its initial investment.
How to calculate payback period
Amount remaining to recover
——————————————-
Amount recovered in the following year
X12
What is Average rate of return (ARR)
Calculated the annual average return over the life of an investment with other alternatives.
How to calculate ARR
Average annual profit
———————————. X 100
Assets initial cost
What are the steps of ARR?
The steps include
Total income from investment - cost of investment = total profit from investment
Total profit from investment
—————————————- X100
Expected lifespan of asset
Average annual profit
——————————— X 100%
Cost of investments
What are some advantages of payback
- simple and easy to calculate and understand
- focus on cash flow
- Strait forward to compare
Disadvantages of payback
Ignores cash flow after payback has been reached
May encourage short term thinking
Ignores qualitative aspects of a decision
What is discounted cash flow
NPV takes into account the future value if money by discounting cash flows.
How do you calculate NPV
Net cash flow X discounted factor
What are some financial factors that may affect a business decision?
- rate of interest
Cost, can the firm finance the investment
What are some non financial factors a business may consider
Corporate objectives
Ethics
Industrial relations
What is sensitivity analysis
This is when a business will use variations of forecasting to allow for a range of outcomes. It allows for a business to play out scenarios.
What are some factors that could affect risk.
Timescale of investment
Knowledge of the business investment
If it is in new markets.
