Investment appraisal Flashcards
What is an appraisal?
Is an estimation of a firms value that is used to facilitate its purchase or sale
What is Net Present Value (NPV)?
The sum of the discounted value of the cashflows from the investment
Reasons why time is a factor?
- Risk (trade receivables)
- Inflation- currency value always changing
- Interest
Is it better to have a positive or negative NPV?
The more positive the NPV the better the investment
What are discounts used for?
Discounts are future predictions when calculating value of investment
What is the Internal rate of return (IRR)?
The discount rate that causes a project to have a positive NPV
What does IRR do?
- Represents the average % rate of return on the investment
- Considers that cash may be flowing into and out of the business
What is the rule of IRR?
The higher the rate of return the more desirable the project
What are the negatives of IRR?
-Trial and error because software is needed (tricky to calculate)
- Cannot cope with Varying costs of finances and unconventional cash flows
What are the positives of IRR?
Takes in relevant information
What is the Payback Period?
The length of time it takes for investments to be repaid-the less time the more desirable
What does the PBP technique focus on?
- time value of money
- Discounted cashflow is used
- Any funds after the payback period are excluded
What are the negatives of PBP?
- Ignores cash inflows which are relevant
- Doesn’t always provide clear signals and can be impractical to use.
What are the positives of PBP?
- Easy to understand
- Can offer a liquidity insight
What is the accounting rate of return (ARR)?
-The only technique that focuses on profit rather than cash flows.
- Projects with ARR above the defined minimum are acceptable, the greater the ARR the more desirable.
Positive of ARR
relatively simple to use and expressed in percentage terms.
Negatives of ARR
- It does not relate directly to shareholders’ wealth.
- It use can lead to illogical conclusions because it ignores some relevant information.
What is the first step of carrying out NPV?
Identify all relevant cashflows and timing
What is the second step of carrying out NPV?
Total cashflows
What is the third step of carrying out NPV?
Discount each total according to the appropriate point in time
What is the fourth step of carrying out NPV?
Total the present value of the various discount values
What is the fifth step of carrying out NPV?
if NPV is positive project is acceptable
Routines for identifying, assessing, and implementing investment projects
-Identify investment opportunities
-assembling the relevant data for investment proposals
- assessing the data in reaching a decision
-implementing the decision
-monitoring effects of decision
