7.8 Investment appraisal Flashcards
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
