investment appraisal

Question 1

investment appraisal

Answer 1

evaluating the profitability or desirability of an investment project (is it worth it?)

a business can also use this to compare different investment projects

Question 2

payback period

Answer 2

the amount of time it takes for a project to recover or pay back the initial cost of the project

Question 3

capital cost

Answer 3

the amount of money spent when setting up a new venture

Question 4

payback calc

Answer 4

amount required/net cash flow in a year

Question 5

advantages of payback period

Answer 5

• simple to use
• Focuses on cash flows - good for use by businesses where cash is a scarce resource
• Emphasises speed of return; may be appropriate for businesses subject to significant market change

Question 6

disadvantages of payback period

Answer 6

May encourage short-term thinking

Ignores cash flows which arise after the payback has been reached - i.e. does not look at the overall project return

Question 7

average rate of return calc

Answer 7

net profit per annum / cost x100

Question 8

average rate of return

Answer 8

measures net profit per annum as a percentafe of initial spending

Question 9

2 advantages of average rate of return

Answer 9

• allows for range of products to be compared
• Focuses on profitability (a key issue for shareholders)

Question 10

2 disadvantages of average rate of return

Answer 10

• Does not take into account cash flows - only profits
• Takes no account of the time value of money

Question 11

discounted cash flow

Answer 11

takes account of the time value of money to estimate the present value of future cash flows associated with an investment project with use of interest rates

idea is that money in the future is worth less than having that money now

Question 12

adv and disadv for discounted cash flow

Answer 12

accounts for value of future earnings, can be changed as risks and conditions in financial markets change

however, calculation is more complex than others