Investment Appraisal

Question 1

Payback period defintiion

Answer 1

A simple investment appraisal approach which calculates the length of time taken for a project to return the original investment into it

Question 2

2 advantages of payback period

Answer 2

• Very simple to calculate
• Short term forecasts are likely to be more reliable

Question 3

2 disadvantages of payback period

Answer 3

• Focuses only on recovery of cash and overlooks the long-term benefits of a project
• Ignores time value of money

Question 4

ARR definition

Answer 4

Investment appraisal tool which looks at the average return for a project to see if it meets the target return

Question 5

ARR formula

Answer 5

Average annual profit / Initial Investment

x 100

Question 6

ARR is expressed in what unit?

Answer 6

Percentage

Question 7

The Time Value of Money in NPV

Answer 7

This is basically stating that it is better to receive cash now rather than in the future. So in NPV, we use discount factors to bring cash flows back to their “present value”

Question 8

How to do NPV

Answer 8

1. Multiply each of the project’s future cash flows by the discount factor resulting in a present value
2. Add all the present values
3. NPV = Total Present Values - Initial investment