7.8 Investment appraisal Flashcards
(13 cards)
What is investment appraisal
The process of appraising or working out whether an investment is likely to meet the business’ project objectives
Uses of investment appraisal
- Whether an investment is profitable enough or whether it pays back quickly enough
- Can compare one project with another project and decide which project is the most suitable for the business’ needs
- Can decide whether any potential return is worth the risk associated with an investment
What information is needed for Investment Appraisal
- Payback
- Average rate of return (ARR)
- Net present value (NPV)
How to calculate payback
- how many years it takes
IF there is some time left then
what is left to pay / what you could pay
What is payback
- Period of time for cash flow to be equal to the initial cost of a project
- Shorter : quicker the business recovers its original investment
Why is payback used
To compare the project with other projects and businesses with liquidity concerns may choose a project with the quickest payback
What is ARR
- Expressed as %
- Higher ARR%, higher the project return in comparison to the original investment
How to calculate ARR
((Net profit - Initial Cost) / No. of years) / Initial Cost) X 100
Why is ARR used
To compare the project with other projects, including investing the money in a bank account and accruing interest
How to calculate NPV
net cash flow x Discount factor = present value
present value - initial cost
What is NPV
- Expressed using a real value in pounds and pence
- It discounts the value of future inflows to reflect that future inflows are worth less than if they were received today
What does a negative NPV suggest
A project will not make a business any money
What does a positive NPV suggest?
A project will produce return for the business
