investment appraisal Flashcards
what is investment apprasial
- quant methods used to evaluate and decide whether to take place with a planeed investment
- consuder the potential value to the firm
- planned investment can cost considerable sums, so need to asses best option to minimise risk and maximise financial gains
- considers how quickly get money back and which planned invesment option will generate the best net gain- profit
why do businesses need to invest
capital investment is needed- keep up with comeptition, help business grow, increase MS, keep up with new tech
to be able to expand into new markets
- new staffing, buildings tech, training, R+D,
replace worn technology-
autonomous investment, if have obsolete ech- puts firm at comp disadvantage
what is net cash flow
NCF is a mesaure of total cash flowing in and out of the business
helps business understand financial gains from investing in particular project
higher the NCF= quicker project will repay intitial investment
what is payback technique
how quickly an investment is able to repay the money they invested unto a project
- quicker payed back sooner can be reinvested into other projects
- particaully important in market swhich chnage rapidly e.g. ICT
- often financed through loans so the faster the repatment the wuicker can repay
- allows us o compare which investments oay back fastest
what is cumulative cash flow
value of net cash flow added to cost of intial investment
will be - until repayed
how to calculate payback
1- calculate CCF (cumulative cash flow )
this is done by adding the NCF for year 1 to initial cost of investment / initial CCF , - shown in ()
2- then adding this value to the next NCF
3- this creates CCF for each year
4-CCF for last year of - figures () / NCF next year after one with () X12
answer should be ….. years and rounded up months
IGNORE - SIGNS WHEN DIVIDING NO - MONTHS
Advantages and disadvanatages of payback
+ quick and simple caculate
+ clear focus on cash flow, helps manage
+ useful frims operating in fast market need a quick return on investment
-ignores all future cash flows beyond payback prediod
- takes no account of time value of money
- ignores totoal proditability just focuses on the speed the intiial outlay is repaid
-only quant assesment of investment
- reliability of data
ARR- average rate of return
value of the average annual profit generated bt an investment against the initial cost
- enables combarison to be made between the investment and other uses for mon ey, e.g. keeping bank in money isntead of investing
- % of initial investment allowing comparison between diff financial options
- considers profitability of investment over its entire life time and doesnt stop once payback is reached
how to calculate ARR
1- caculate CCF
2- divide the final CCF ( most likely +) by the lifetime of the project- years
this finds out how much prodit generated on average each year- AAP average annular profit
then divide this by the initial cost of investment and X by 100 =%
the higher the percentace = more attraxctice and less risky
benefits and drawbacks of ARR
+ shows the profits of each option
+ takes all cash flow values into account
+ allows meaningful comparison with other forms of investment
+ can compare ARR value against the cost of borrowing
- takes no account of external factors like inflation
- ignores timings of cash flows
what is NPV - net present value
only method that takes into account the time value of the money
recognises money earned in the future is woeth less than money earned today due to e.g. inflation
it realises that the value of money usually decreases over time
regongnises higher levels of risk involved when cash flows are projected to be generated a long time into the future
how to calculate NPV
NO USE OF CUMULATIVE VAULUE
multiply NCF with the discount value for each year
this gives us the present value, valur of future cash flows in terms of their value in todays spending terms
add up all of the present values and SUBTRACT from initial cost of investment = NPV
if positive- investment is viable but negative value- investment isnt finaically viable
benefits and drawbacks of NPV
+ only methods that takes into account the time value of money
+ allows earings of a project to be put into presecent values
+ discount factors can be changed to reflect diff market conditions
- the further into the future cash flow projections the less accuratr the discount factor will be ( hard to predict future )
- assumes inflation will be constant - not relaistic
- complex to conduct and interpret
Qualm factors consider
impact of investment on
- staff
redudancy, new tech
retraining
resist change
- impact of the economy
cost of borrowing
boom or slowdown
is this the correct time to invest - actions of competitors
are they investing , new tech ?
are they beining to gain more market share - impact in stakeholders
share prices rise ?
local community imoact
job losses due to investment
evaluation
NO major decision on investment would be made purely on QUANT techniques - IA
must consider QUAL e.g. ethocs, impact stakeholders and whether decision supports objectives
does the business have the financial strength, if fails will cause business to faul, are they already highly geared cant afford to borrow more
what is their liquiditiy position
helps managers make informed deicisions
