7.9a Investment Appraisal - Payback Flashcards
Investment definition
The purchase of a non-current asset
Investment decision making definition
Deciding whether to undertake an investment in the business
Reasons for investment:
- Replace or renew old assets
- Introduce new assets
- Help business achieve functional objectives
What type of approach does investment appraisal have to decision making?
Scientific
Do appraisals use quantitative or qualitative information first?
Quantitative then qualitative
When considering to invest or not, a business will look at:
- The initial cost
- The net return per annum
- How long it will be used in the business
Net return formula
Net return = annual revenue - annual cost
What does payback work out?
How long an investment will take to pay for itself
Cumulative returns definition
Running total of how much money the investment has cost/earned the busienss
Payback formula
Payback = (total left / net returns in that year) x 52
Advantages of using payback:
- Simple to calculate
- Easy to compare projects
- Emphasises speed of return
Disadvantages of using payback:
- Ignores cash flows which arise after payback has been reached
- Takes no account of time value of money
- Ignores qualitative aspects of a decision
