investment appraisal

Question 1

define payback period

Answer 1

used to work out the number of years and months it would take for an investment of a business to pay for itself.
when the cumulative net cash flows are equal to the initial investment cost, the business has reached its pbp.
longer pbp=higher risk, cuz more bad things can happen

Question 2

calculate payback period, what r the time periods in which it can be calced?

Answer 2

years/months (x12)
years/days (x365)
years/weeks (52.143)
365/7
formula:
(amount left to pay / net cash flow in final year) X 12 (or 365)
amount left to pay = cumulative net cash flow.
net cash flow in final year = n/f of next yr.

Question 3

compare and evaluate investment opportunities using the pbp.

Answer 3

+:
1. simple to calc (npv=hard)
2. easy to interpret (npv =hard cuz of discount rate)
3. good for business w cash flow issues - cuz it prioritizes quick payback times.
-:
1. only relies on cash flow forecasts - estimates and predictions
2. doesn’t look at the cash earned by busienss and how that could contribute to the pbp, esp aft inv has been paid off
3. ignores the timing of the payments - when r u gonna pay x amount to ur suppliers or to the bank, how would this help the business/contribute.
4. does not look at any external factors that would affect cash flow - STEEPLE.
5. ASSUMES THAT THE FUTURE CASH INFLOWS HAVE THE SAME VALUE RN EVEN THO THEY WOULD DECREASE (however npv does look at this)

Question 4

what are the steps involved in calculating pbp?

Answer 4

1. calc net cash flows for each year
2. calc cumulative cash flows - sum of all the years. (negative plus positive)
3. calc pbp.

Question 5

define average rate of return

Answer 5

investment app technique that expresses the annual forecast returns as a percent of the initial capital cost.

Question 6

calculate arr, how is this value represented?

Answer 6

((total returns - capital cost / years of use) / capital cost) x 100.
total returns = net cash flow
represented as a percent the higher the better cuz It means the higher the chances ur investment
evrtry year how much r u making back based on how much ur inv cost.

Question 7

compare and evaluate investment opportunities using the arr.

Answer 7

+:
- shows the profitability of an inv over a given period of time - good for managers to make decisions and allocate work accordingly - decision tree
- looks at the use of all the cash flows in the business (not like pbp)
- allows for easy comparisons - esp to see bank interest in loan, if interest is higher than arr then not worth it.
-:
- if arr is for a longer period could increase/have effort withth long term forecasting cuz of external factors (steeple)
- does not consider the timing go the cash inflows so when they would come into the business
- value of money and those effects aren’t considered. - saving money arr doesn’t take that into consideration.
however each + snd - does have an opp cost.

Question 8

how to calc average annual return

Answer 8

total ncf’s over the lifetime of inv / number of years
u don’t need this formula to calc arr but u should have it

Question 9

what r the steps involved in calculating the arr

Answer 9

1. add all ncf’s
2. sub the cost of the inn
3. devide by the lifespan
4. divide annual profit by go cost of inv
5. multiply by 100.

Question 10

define the net present value

Answer 10

Another investment appraisal method, net present value (NPV) , shows the real value of estimated future net cash flows so that the investment appraisal is more accurate.
* A method of making investment appraisals more accurate by using a discount rate to adjust the value of future returns.

Question 11

how to calc the npv, how is this value represented?

Answer 11

total present value - og cost.
money (dollars etc)

Question 12

what is a discount rate and how to calculate it?

Answer 12

the rate a business could ear n on another comparable inv. number, based on the years and interest rates - calc current value of future inflows!!!.
bcz as time goes on the value of money decreases.

Question 13

how to calculate the present value (single year)?

Answer 13

net csdh flow for each year multiplied by the discount rate
discount r I in decimals and its diff for each separate year cuz it adds up the previous yr.

Question 14

compare and evaluate investment opportunities involving the npv

Answer 14

+:
- time value of money was taken into account
- all cash flows and timing is included - allows managers to have a good idea of this and create a decision tree.
- compare diffeeenr opportunities - decision tree
- the discount rate is changed to suit any Econ factor - steeple.
-:
- more complicated to calculate than pbp and arr.
- disc rate largely impacts npv result so if one thing is wrong it could mess up the whole thing.
- disc rate assumptions need to be looked at critically - may be affected by wrong interest rate predictions.

Question 15

5 qualitative techniques a business needs to consider when making an investment

Answer 15

1. product life cycles - if ur good is in the growth phase, if their sales r gonna grow a lot more then they should invest in that product more.
2. BCG matrix - products that are deemed to be good will be prioritized.
3. steeple analysis - esp Mnc(external factors In difff countries)
4. product portfolio analysis: maybe there is a gap in a specific product - more inv req.
5. market research results - ratings, comments, feedback etc

Question 16

5 quantitative techniques a business needs to consider when making an investment

Answer 16

1. ROI
2. break even (where total rev = total costs)
3. market share - value of a single businesses sales/rev’s compared w the sales of the whole industry]/all businesses.
4. financing SOF/IA - techniques - if arr is higher than interest rate on loan = good (eg).
5. cash flow assumptions/forecasts/statements. PBP/ARR/NPV.