INVESTMENT APPRAISAL Flashcards

1
Q

Investment Appraisal

A

The quantitative techniques used in evaluating the viability or attractiveness of an investment proposal. It aims to establish whether a particular business venture is worth pursuing and whether it will be profitable.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

3 methods:

A
  1. Payback period
  2. Average rate of return
  3. Net present value
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Payback period

A

Estimates the length of time required for an investment project to pay back its initial cost outlay.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Payback period formula

A

Initial investment cost / Annual cash flow from investment

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Cummulative cashflows

A

When the yearly cashflows are different. The cummulative cashflow must be calculated first.

Formula: extra cash inflow required / annual net cashflow in the next year x 12

Extra cash inflow needed: Last negative number of cummulative cash flows

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Advantages of payback period

A
  • Simple and fast to calculate
  • Useful method in rapidly changing industries. Helps estimate how fast the initial investment will be recovered before purchasing a new machine.
  • Helps firms with cashflow problems.
  • Since it is a short term forecast, less likely to have inaccuracies.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Disadvantages of payback period

A
  • Does not consider cash earned after payback period, could influence major investment decisions.
  • Ignores profitability of invetsment
  • Annual cash flows could be affected by unexpected external changes in demand.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Average rate of return

A

Measures the annual net return on an investment as a percentage of its capital cost.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Average rate of return formula

A

((total returns - capital cost) / years of usage) / capital cost x 100

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Advantages of Average Rate of Return

A
  • Unlike payback period, it makes use of all the cash flows in a business.
  • Allows for easy comparisons with other competing projects for better allocation of investment funds.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

Disadvantages of Average Rate of Return

A
  • Considers a longer time period, innacuracies in forecasting are more likely.
  • Does not consider the timing of cash inflows. Two proejcts would have the same ARR but one pays back faster.
  • The effects on the time value of money are not considered.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

Net Present Value

A

The difference in the summation of present values of future returns and the original cost of investment.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

Net Present Value Formula

A

Total present values - original cost

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Net Present Value Formula Advatages

A
  • The opportunity cost and time value for money is put into consideration in its calculation.
  • All cashflows, including their timing, are included
  • The discount rate can be changed to suit any expected changes in economic variables, such as intrerest rate variations.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Net Present Value Formula Disadvantages

A
  • More complicated to calculate
  • Can only compare invetment projects with the same initial cost outlay
  • The disocunt rate greatly infleunces the final NPV result, which may be affected by inaccurate interest rate predicitions.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Discounted cash flow

A

uses a discount factor that converts future cash flows to their present value.