Investment appraisal Flashcards
What is the formula for ARR %?
Average profit/ initial or average investment
What is the decision rule with ARR?
Projects above a min ARR are acceptable
What does a higher ARR mean?
More desirable project
What are the advantages of using ARR?
- Quick and simple
- Easily understood
- Uses FS numbers
- Looks at entire project life
What are the disadvantages of using ARR?
- Manipulation
- Subject to accounting policies
- Relative %
- ignores timing of CFs
What is the payback period?
Time required for cashflow inflows from capital investment to equal initial cash flow
What is the decision rule with the payback period?
Project with min payback time are acceptable
What are the advantages of the payback rule?
- Quick and simple
- Easily understood
- Can enhance liquidity
What are the disadvantages of the payback rule?
- Ignoring timings of CFs
- Ignores time value of money
- Ignores the cash flows after end of payback period
- Excessive investment in short term projects
How is NPV calculated?
Original amount, decreased by DF
What is the internal rate of return formula?
a + (NPVa/NPVa - NPVb) x b -a
a = first discount rate
b = second discount rate
How is the DF calculated?
1/1.X
What calculation does an estimate of IRR require?
NPV at two different discount rates.
Is an investment with a positive NPV financially viable?
Yes
Does the graph of NPV against discount rate has a negative slope for most projects?
Yes
What is NPV?
Present value of expected future net cash receipts less the cost of the investment
What the advantages of the payback method?
- Focus on a short payback period enhances liquidity
- Investment risk is reduced if the payback period is shorter
- Useful as an initial screening device
Does ranking projects by NPV give the same result as ranking by payback?
Yes
Does ranking projects by payback give the same result as ranking by IRR?
Yes
Costs of developing performance measures and testing and inspecting are classified as which type of cost?
Environmental appraisal costs
What environmental costs would be classified as environmental external failure
costs?
- Cleaning contaminated soil
- Government penalties
What is included in the total environmental appraisal cost?
Testing and inspection
