Investment Appraisal

Question 1

Investment appraisal

Answer 1

Investment appraisal describes how a business might evaluate an investment project to determine whether it’s likely to be profitable or not. 

Question 2

Average Rate of Return (ARR)

Answer 2

Net return (profit) per annum/capital outlay (cost) x 100 (%)

Question 3

Advantages and Disadvantages of ARR

Answer 3

A: Shows the profitability of an investment in annual percentage terms so other investments can be compared to it.
D: averaging data masks opportunity costs, so ARR provides oversimplified results. 

Question 4

Criterion Levels

Answer 4

This is the boundary between acceptable and unacceptable investment proposals. 

Question 5

Advantages and disadvantages of criterion levels

Answer 5

A: helps avoid wasting time and work into something the board won’t accept.
D: Easy to manipulate figures to boost ARR

Question 6

Discount Factor

Answer 6

This is the rate of interest chosen to represent the company’s cost of capital.

Question 7

Advantages and Disadvantages of discount factor

Answer 7

A: it discounts progressively over time, taking full allowance of opportunity of cost time.
D: makes data too complex for most staff to understand.

Question 8

Discounted cash flow

Answer 8

Downgrading future cash flows progressively over time to allow for time value of money. Each year is forecast net cash flow is multiplied by a discount factor (less than 1%)

Question 9

Advantages and Disadvantages of discounted cash flow

Answer 9

A: takes into account opportunity cost of capital.
D: requires good guess about future interest rates.