3.3.2-Investment Appraisal

Question 1

What is Investment Appraisal ?

Answer 1

Attempts to determine the value of capital expenditure projects. It enables businesses and investors to compare projects so that the business can expand and meet their projects

Question 2

Investment Appraisal - Planning Process

Answer 2

• Investment appraisal is the planning process used to determine whether the long term investments will give the best return.
• Projects such as;
• new machinery
• new premises
• research and development projects

Question 3

Investment Appraisal- Decision Making

Answer 3

A business will have lots of ideas for projects, and proposals of ways to grow their business. The business will only have a finite amount of money and so perhaps only one project will get the funding it needs to go ahead. Investment appraisal is used to work out which project should get the funds.

Question 4

Payback Calculation

Answer 4

How long it will take to pay back
Its going to cost the business £95,000 to get this project up and running
• Year 1 the project makes £10,000
• Year 2 the project makes £40,000
• Year 3 the project makes £40,000
• So far it has paid back £90,000
• Now we need £5,000 more from year 4 so:

5,000/60,000 x 12 = 0.9 (round to 1) = 1

Question 5

Average Rate of Return Calculation

Answer 5

Lets look at proposal 3
1. Add up all the cash inflows from years 1-5 = £150,000
2. Then minus the original cost of the project = £70,000
3. Then divide this by the number of years the project runs for:

70,000/5 = 14,000

4. Now take this figure and divide it by the cost of the project

14,000/80,000 x 100 = 17.5%

Question 6

What is a decision tree?

Answer 6

A business can’t afford to follow every option so it may use a decision tree to analyse the probability of a success in a choice of strategies;
• A new product launch
• A new marketing campaign on the current product
• Relocation to a new building

Question 7

How to draw a decision tree

Answer 7

Reference 3.3.3 slides page 10