investment appraisal Flashcards
what is investment appraisal?
technique used to evaluate planned investments by a business and measure planned financial value to business.
what is the purpose of investment appraisal?
covers several techniques of appraising an investment and uses quantitative data such as cost of investment and predicted inflows.
then mostly compare one IA opportunity with another to deciide which offers best value.
what are the 3 methods of investment appraisal?
payback period
average rate of return
discounted cashflow
what is payback period?
calculating how long it takes business to get its money back from investment?
how do you work out payback period?
work out number of FULL years until payback.
divide amount of money needed by amount of money you’re getting in that year.
multiply this answer by 12.
this is the amount of months to go with the year.
draw an extra column on to help work out how many years.
advantages of payback period?
simple to use
easy to calculate
effective to use with tech changing so quick to recover cost of investment asap
helps when managing cashflow
disadvantages of using payback period?
ignores cash flow over lifetime of project.
ignores total profitability as focus is just on speed of repayment.
how to work out ARR?
calculate overall PROFIT (may have to subtract rev from costs)
divide this by life span
divide by cost of investment
x100
what should you do if ARR is below interest rate?
leave it in the bank.
what is the rough current interest rate?
5%
advantages of ARR?
shows profitability of project including cash flow.
easy to compare with other projects.
can compare with cost of borrowing for investment.
disadvantages of ARR?
ignores timing of cash flow.
ignores inflation on values of future cash flow.
what is net present value?
discounted cash flow method of IA takes value of money over time into account.
value of future money if you had it now.
how to work out npv?
income x discount factor
add each year together
subtract cost of investment
do you want npv to be positive or negative?
positive!
advantages of using npv?
allows for future earnings to be adjusted to present values.
easy to compare to different projects.
allows impact of inflation
discounts can be changed to take into account changes in economic climate.
disadvantages of npv?
difficult to calculate
discount factors may be incorrect.
difficult to set discount factors for very far in the future.
factors affecting which IA is most important?
size of business - is short term cashflow important?
is inflation likely to be stable?
how risky
factors affecting investment appraisal decisions?
impact on staff - training/redundancies.
impact on existing products.
does investment match strategy and objectives of business.
state of economy
competitor actions
sufficient funding?
why might a business be mainly bothered about a short payback period?
if they are new and don’t have a consistently strong cashflow so need money back asap.
