3.3.2 - Investment Appraisal (USE FOLDER for EXAMPLES) Flashcards
1
Q
What is Investment Appraisal?
A
Evaluation of an Investment Project to Determine Whether or Not It’s Likely to be Worthwhile
Involves Comparing the Captial Cost of Project with the Net Cash Flow
2
Q
State Payback Period Definition
A
Amount of Time it Takes for a Project to Recover or Pay Back the Initial Outlay
3
Q
What are Advantages of Payback Method
A
- Method is Useful when Technology Changes Rapidly as it’s Important to Recover the Cost of Investment Before a New Model is Designed
- Firms might Adopt this Method If they Have Cash Flow Problems -> Because the Project Chosen will ‘Payback’ the Investment More Quickly Than Others
4
Q
What does the Average Rate of Return Measure?
A
Measures the Net Return Each Year as a % of the Captial Cost of Investment
5
Q
State Formula for Average Rate of Return?
A
Net Return (Profit) per annum / Capital Outlay (Cost) x100
USE FOLDER
6
Q
State Advantages of ARR
A
- Clearly Shows the Profitability of an Investment Project
- can be Compared to Other Uses for Investment Funds
7
Q
What is Net Present Value (NPV)
A
- the Present Value of Future Income from an Investment Project, Minus the Cost
- Takes Into Account that Money In the Future Isn’t Worth What’s it Is Today
- Adds Discount Table to Make it More Realistic
8
Q
State Advantage of NPV
A
- the Discounted Cash-Flow Method Correctly Accounts for the Value of Future Earnings, unlike Payback and ARR, by Calculating the Value of Future Earnings by Calculating Present Value
9
Q
What is the Limitations of Payback
A
- Very Simple, Only Looks at Speed of Payback and Overloooks Profitability
- Cash Earned After Payback is Ignored
10
Q
What is the Limitations of ARR?
A
- Doesn’t Take into Account the Effects of Time on the Value of Money
11
Q
What is the Limitation of NPV
A
- Very Complex, Not Used by Small Business, also Results Dependent on Rate of Discount Used, the Higher the Rate the More Likely it is that Project will be Rejected as Unprofitable
