3.7.8 Investment Appraisal

Question 1

what is investment appraisal?

Answer 1

the process of analysing the financial merits of a possible future investment

Question 2

what is payback?

Answer 2

the length of time it will take to pay back the initial cost of investment

Question 3

advantages of payback:

Answer 3

easy to understand
important to businesses with cash flow problems

Question 4

disadvantages of payback:

Answer 4

ignores the overall profitability of the project
it assumes that cash inflows remain steady

Question 5

what is average rate of return?

Answer 5

assess the worth of an investment by calculating the average annual profit as a percentage of the initial investment.

Question 6

advantages of ARR:

Answer 6

allows for easy comparison with other forms of investment
can be compared to current or target ROCE

Question 7

how do you calculate average rate of return?

Answer 7

1. calculate cash flow
2. divide cash flow by the number of years it’s spread over
3. calculate this as a % of the original investment

Question 8

what is net present value?

Answer 8

the present value of future flows of money.

Question 9

advantages of NPV:

Answer 9

rule of +ve and -ve NPV provide an easy guide
takes into account the time value of money

Question 10

disadvantages of NPV:

Answer 10

does not account for the speed of repayment
can be difficult to choose correct discount factor
non-finance managers may find it hard to understand

Question 11

how do you calculate net present value?

Answer 11

1. calculate the present value of all cash inflows
2. deduct the original investment from the present value of all cash flows

Question 12

what is investment criteria?

Answer 12

a pre-determined set of targets against which to judge an investment.

Question 13

what is sensitivity analysis?

Answer 13

a technique that uses variation in forecasts to allow for a range of outcomes