Investment Appraisal

Question 1

Payback period

Answer 1

The time taken for cash inflows from a project to equal the cash outflows

Question 2

Accounting Rate of Return

Answer 2

Average annual profit from investment/initial investment

Or

Average annual profit from investment / average investment

Where average investment = Initial outlay + scrap value / 2

Note: profit is after depreciation

Question 3

Net Present Value

Answer 3

The maximum an investor would pay for a given set of cash flows (at their cost of capital) compared to the actual amount they are being asked to pay.

The difference, the NPV, represents the change in wealth of the investor as a result of investing in the project.

Question 4

Internal rate of return

Answer 4

A cost of capital at which the NPV of a project would be 0.

IRR is usually found via interpolation using two discount rates.

IRR = a + NPVa/NPVa-NPVb (b - a)

Where ‘a’ is the first (lower) discount rate giving NPVa.
‘b’ is the second (higher) discount rate giving NPVb

Ideally, but not necessarily, NPVa should be a positive value and NPVb a negative value.

Question 5

Opportunity Cost

Answer 5

The cash flow foregone if a unit of the resource is used on the project instead of in the best alternative way

Question 6

Capital rationing

Answer 6

The situation where insufficient funds exist to undertake all positive NPV projects, as a choice must be made between projects

Question 7

Shareholder value analysis (SVA)

Answer 7

The process of analysing the activities of a business to identify how they will result in increasing shareholder wealth.

Question 8

Criteria for investing in a country

Answer 8

Market attractiveness, Competitive advantage, and Risk

Question 9

Deprival value is the lower of

Answer 9

Replacement cost
&
Recoverable amount (higher of Value in use, and NRV)