investment appraisal Flashcards
investment appraisal
process used to determine whether funds given to a business for investment are likely to generate a profit. Used to evaluate investment.
helps to
assess the general feasibility of undertaking a project
consider other approaches such as undertaking a projects or just leaving money in bank gain interest
reveal the level of investment required for project to be successful, showing investors possible rates of return and risks.
pay back
the amount of time it takes for a business to recover the initial amount invested.
pay back formula
if net is constant = sum invested/ net cash per time period.
pay back fluctuates
investment outstanding/ monthly cash in year of payback
average rate of return
The average annual return on an investment for a project expressed as a percentage.
formula for average rate of return
average annual profit/initial outlay x 100
discounted cash flow
the process of calculating the present value of an investments future cash flows in order to arrive at a current value of the investment known as the present value
net present value
the present value of all the money coming in from a project in the future set against the money invested today
payback +
easy to use simple to interpret
focuses on cash, crucial to everyday success of a business.
easy to compare competing investments when resources are limited.
payback -
encourages short term thinking about the investment
ignores qualitative aspects of a decision which option meets needs of customers.
ignores cash flow after payback has been completed and therefore cannot be used on its own to make decision about investment.
average rate of return +
uses all the cash flows over life of project
focuses on profitability.
makes decision making easier as easy to compare returns on range of different investments.
average rate of return -
projected cash flows may prove to be inaccurate and will affect ARR.
ignores timing of cash flows which may only be positive towards end of investment.
ignores opportunity cost aspect as does not account time needed to benefit from investment.
Net present value +
takes into account opportunity cost of the money
takes into account timings and amounts of cash flow
can be used to consider different investment scenarios in terms of interest rates.
Net present value -
The results can be misunderstood
projects only be compared if initial investment is the same.
