3.3.2 Investment Appraisal

Question 1

Limitation of payback

Answer 1

Tells us nothing about profitability
• Ignores what happens after payback is achieved
• May encourage a short-termist attitude

Question 2

ARR Limitations

Answer 2

Ignores the timing of cash flows
• Therefore values far distant inflows
as much as more immediate inflows,
which are worth more
• Including forecast data from far in the
future may reduce the reliability of the
forecasts and therefore results

Question 3

Limits of NPV

Answer 3

Complex to calculate and
communicate
• Meaning is often misunderstood
• Only comparable between different
projects if the initial outlay is the same

Question 4

NPV advantages

Answer 4

Takes the opportunity cost of money
into account
• Considers both amount and timing of
cash flows to indicate profitability

Question 5

Non-financial factors also to be considered

Answer 5

Corporate objectives, company finances, confidence in the data, social responsibilities

Question 6

Corporate objectives

Answer 6

Does the chosen investment focus on achieving

the agreed objectives of the business?

Question 7

Company finances

Answer 7

Expensive investments that may place the firm’s

financial health at risk if they require external finance may be better ignored.

Question 8

Confidence in the data

Answer 8

It is always worth considering the likely
accuracy of the forecasts on which calculations are based: who prepared
the forecasts; do they have a record of success in forecasting; do they have
some bias that could cause them to over or underestimate cash flows?

Question 9

Social responsibilities

Answer 9

If an investment clearly helps to meet a business’s
social responsibilities, some businesses may be willing to proceed even
if the project is not the most financially attractive option.