Investment appraisal Flashcards
Why do businesses need to invest
1 to meet objectives
2 to move business forward
3 to keep up with competitors
What areas does a business invest
1 capital goods - goods used in production
2 research and development
What is investment appraisal
Technique used to evaluate a planned investment an measure its potential value
What are the 3 categories of investment
Autonomous (replacement of goos)
Induced ( new investment due to expansion)
Availability of new technology
Why do businesses carry out research when investing
To help to decide on which investment is most likely to be the most profitable an how long it will take to get back the initial amount invested
List the investment appraisal methods
1 payback
2 average rate of return ARR
Discounted cash flow
What is payback period
The amount of time it takes for the project to payback the initial outlay
JUDE
LOOK AT EXAMPLES FROM THE BOOK!!!!
If there are a number of investment options which one will the payback method select
The one that returns the initial cost in the shortest time
What does the ARR method measure the net return every year
It is expressed as a % allowing a straight forward comparison between investment options
JUDE
LOOK AT EXAMPLES FROM THE BOOK
Describe the discounted cash flow method of investment appraisal
Takes into account the time value of money
It calculates the net present value NPV of different options or projects (takes into account inflation and potential earnings on interest)
Basically it acknowledges money in the future is worth less
JUDE LOOK AT EXAMPLE
Why is selecting the most appropriate investment appraisal not straight forward
1 often not appropriate to use 1 method
2 one option may have shorter payback or better ARR
3 another option may have higher DCF
What points need to be considered when selecting the most appropriate investment appraisal
1 is the investment hi tech - if so short payback maybe require since technology is fast evolving
2 is short tern cash flow important - this may rule out or in short pay back times
3 is inflation likely to be table will NVP figures be reliable
4 how much risk is involved
Advantages of using DCF and NPV
1 allows for future earnings to be adjusted to present values
2 easy to compare different projects
3 allows for impact of inflation on value of future cash flow
4 discounts can be changed to take into account the economic and financial climate
5 allows for effect of risk on estimated future cash flows
Disadvantages of using DCF and NVP
1 its difficult to calculate
2 discount factors could be incorrect making NPV inaccurate
3 difficult to set discount factors far into the future the linger into the future the less reliable the discount factor
What other factors need to be considered before a decision to invest is made
1 impact on staff- can they handle the change brought about by the investment - trained to use new technology, will their be4 redundancies
2 impact on existing product - will concentrating on the new product be detrimental to existing lines
3 does the investment match the objectives of the business
4 state of the economy - is it booming or in recession which decreases demand
5 actions of competitors - are they investing or improving products
6 does the investment have ethical considerations - is it going to damage the environment
7 is there enough funding to invest in the project. Is the business going to be at risk by reducing the cash flow or increased borrowing
8 availability of new technology
9 confidence of managers
