7.8.1 Investment Appraisal

Question 1

Investment Appraisal

Answer 1

Investment appraisal allows a business to work out whether an investment is profitable enough, or whether it pays back quickly enough. Investment appraisal also allows a business to compare one project with another project and decide which project is the most suitable for the business’ needs.

Question 2

Risk of Investment

Answer 2

Investments carry risk for businesses as all investments require a financial commitment. Investments involve taking risks in the hope of a possible reward, or profit. Investment appraisal allows businesses to decide whether any potential return is worth the risk associated with an investment.

Question 3

Net Present Value

Answer 3

Net Present Value is expressed using a real value in pounds and pence. A negative NPV suggests that a project will not make a business any money whereas a positive NPV suggests that a project will produce a return for the business.

Question 4

Average Rate of Return

Answer 4

Average Rate of Return is expressed as a percentage and is calculated using:
(Average net return ÷ investment) × 100
The higher the ARR percentage, the higher the project return in comparison to the original investment.
The ARR can be used to compare the project with other projects, including investing the money in a bank account and accruing interest.

Question 5

Payback

Answer 5

Payback is expressed as a period of time. It is the amount of time for cash flow to be equal to the initial cost of a project. The shorter the payback, the quicker the business recovers its original investment. The payback period can be used to compare the project with other projects and businesses with liquidity concerns may choose a project with the quickest payback.