3.8 Investment appraisal

Question 1

payback period

Answer 1

the calculation of the length of time that it takes for a capital investment to pay for itself, by estimating future cash flow each year and working out the month and year in which the cash flow will finally cover the investment cost

Question 2

cumulative net cash flows

Answer 2

cumulative net flow in previous year + net flow of current year

Question 3

payback period formula

Answer 3

(amount left to pay/ net cash flow in that year) x (12)

Question 4

limiation of payback period method as a appraisal method

Answer 4

• ignores the long term profitability of an investement.
• more desirable investment may be overlooked because it has a longer payback period.
• assumes that future cashfows have same values as those today
• different businesses prioritise different things

Question 5

average rate of return (ARR)

Answer 5

an investment appraisal technique that expresses the annual forecast returns as a percentage of the initial capital cost.

Question 6

investment appraisal

Answer 6

a process of quantitive and qualitative evaluation of an investment decision

Question 7

what does investment appraisal include

Answer 7

opportunity cost- potential cost of missing an opportunity by choosing one option and foregoing another

Question 8

methods of investment appraisal

Answer 8

quantative techniques: payback period, avarage rate of return, net present value
qualatititve techniques: market research results, steeple analysis, product life cycle analysis

Question 9

average rate of return formula

Answer 9

{[(total returns- capital cost)/years of use]/capital cost } x100

Question 9

broken down formula for ARR

Answer 9

calculate total net cash flow over the lifetime of investment minus the capital cost
divide the result from step 1 by the number of years of the project
divide the result from step 2 by the projects initial investment cost. convert thi number into a percentage

Question 10

interpreting ARR

Answer 10

• ARR must meet minimum average rate of return
  take risk into acount, high ARR means high risk

Question 11

net present value

Answer 11

a method of making investment appraisals more accurate by using a discount rate to adjust the value of future returns

Question 12

discount rate

Answer 12

rate a business could earn on another comparable investment.

Question 13

present value formula

Answer 13

net cash flow x discount factor

Question 14

net present formula

Answer 14

total present values of return - original cost

Question 15

evaluation of net present value

Answer 15

• benefit is that the method considers change in value of money over time, which provides more accurate understandment of the furture value of cash flows from a investment + compare opportunities with different investment periods
• limitation is that is is more compext to calculate, also assumption for future value of money can be innacurate

Question 16

evaluation of investment

Answer 16

• return on investment
• cost savings
• break even
• market share
• financing
• cashflow assumptions
• the hospitals mission statement

Question 17

qualatative

Answer 17

• product life cycle: product in the growth or maturity phase.
• boston consulting group matrix: products that are deemed to be stars are predicted to have a bright future
• STEEPLE analysis
• product potrfolio analysis
• market research results