Investment Appraisal

Question 1

What is the excel function for NPV?

Answer 1

=NPV(discount, cell range)
e.g., =NPV(0.1,B2:E2)

Question 2

What is the excel function for IRR?

Answer 2

=IRR(cell range)
e.g., =IRR(B2:E2)

Question 3

What are the benefits of the payback period as an investment appraisal method?

Answer 3

• Simple to calculate and understand
• Can use as initial screening tool
• Recognises importance of liquidity
• Focuses on nearest (most certain) future cashflows

Question 4

What are the benefits of the ARR as an investment appraisal method?

Answer 4

• Simple to calculate and understand
• Looks at the entire life of the project
• Reflects the way that external investors judge the organisation (% return)

Question 5

What are the benefits of the NPV as an investment appraisal method?

Answer 5

• Takes into account the time value of money
• Shows the shareholders wealth created by the project
• Can allow for risk (by adjusting the cost of capital
• Clear decision
• Looks at entire project

Question 6

What are the benefits of the IRR as an investment appraisal method?

Answer 6

• Allows for the time value of money
• Does not require an exact cost of funds to be estimated
• Easy to interpret (% return of a project)
• Looks at entire project

Question 7

What are the drawbacks to the payback period as an investment appraisal method?

Answer 7

• Ignores the time value of money (discounted payback can be
  calculated)
• Only considers the cashflows up to the payback date.
• Encourages short-termism
• No clear decision rule

Question 8

What are the drawbacks to the ARR as an investment appraisal method?

Answer 8

• Ignores the time value of money
• Based on profits, not relevant cashflows
• Doesn’t consider the length of the project (and hence liquidity).
• No clear decision rule

Question 9

What are the drawbacks to the NPV as an investment appraisal method?

Answer 9

• Requires the cost of capital to be estimated several years into the future
• Calculations can be time consuming and easily misunderstood
• Doesn’t factor in liquidity / time taken to generate return
• Assumes you can reinvest proceeds at cost of capital

Question 10

What are the drawbacks to the IRR as an investment appraisal method?

Answer 10

• Ignores the size of investment required and total cash inflows
• Can give a conflicting answer to NPV when evaluating mutually exclusive projects (if
  projects of different length / size)
• Assumes you can reinvest proceeds at the IRR