3.8 - Investment Apprasil

Question 1

Define investment

Answer 1

Purchase of an asset that will potentially generate future assets

Question 2

Define investment appraisal

Answer 2

Quantitative technique used to evaluate the pros and cons of investment opportunities

Question 3

What are the 3 tools to evaluate an investment

Answer 3

PBP
ARR
NPV

Question 4

Define pay back period

Answer 4

The length of time required for an investment to recover its initial cost in terms of profit

Question 5

Within PBP when do you know an asset is not worth purchasing

Answer 5

When it become obsolete before PBP

Question 6

What is the formula for PBP

Answer 6

PBP = initial investment cost/cash flow from investment per period x 12 + number of years

Question 7

What are the steps to solving NPV

Answer 7

1. Make a table with 3 columns, 1 with year, one with net cash flow, one with cumulative net cash flow
2. Minus the figure form year 0 and 1 and place that figure in cumulative net cash flow year 1 and continue
3. Take the year in which that last negative cumulative cash flow occurred, that figure and then the following years net cash flow
4. Place these figures into the formula: PBP = initial cash inflow needed/ anual cash flow in next year x 12 months (+number of years)

Question 8

What are the positive of PBP

Answer 8

• simple, easy and quick
• quick way to check viability of investment project or complace investment opportunities

Question 9

What are the negatives of PBP

Answer 9

• only takes time into account, overall project profitability is ingnored
• prediction = too simplistic

Question 10

Define average rate of return

Answer 10

Average profit on investment expressed as % of initial investment (capital cost)

Question 11

Define criterion rate

Answer 11

Internal benchmark for acceptance of investment project

Question 12

What is the equation for ARR

Answer 12

ARR = (total return - capital costs) / years of use / Capital costs x 100

Question 13

Pizza oven XYZ is worth 5000. The expected returns for 5 years of its lifespan are 3000, 2500, 2000, 1500, 1000. Calculate the ARR

Answer 13

Total returns = 10,000, ARR = (10000-5000) / 5 / 5000 x 100 = 20% (then ARR is compared to criterion rate and interests rate and investment appraisal is made)

Question 14

What are the positives of ARR

Answer 14

• simple, easy and quick
• takes account of profitability for entire lifespan

Question 15

What are the negatives of ARR

Answer 15

• ignores timings for return
• just a prediction
• to simple

Question 16

Define NPV

Answer 16

Different between present values of future cash flows and original cost of investment

Question 17

What is the formula for NPV

Answer 17

NPV = sum of present value - original cost

Question 18

Define present value

Answer 18

Todays value of futre cash

Question 19

What do you have to use when calculating NPV

Answer 19

Discount factor table

Question 20

How do you calculate present value

Answer 20

Discount factor x predicated value = present value

Question 21

What are the steps to calculate NPV

Answer 21

1. Create a table with year, net cash flow, discount facto, present value
2. Times net cash flow and discount factor to get present value
3. Add up present value and minus the initial investment to get the NPV
4. If value is positive the investment is worth pursuing

Question 22

What are the positives of NPV

Answer 22

• includes both time and cash value
• flexible : discount factor may be altered along with state of economy
• takes into account many factos

Question 23

What are the negatives of NPV

Answer 23

• more difficult to calculate
• inaccurate: unlikely intrest will be constant throughout project lifespan
• too simplistic to be only tool to rely on