Investment Appraisal Flashcards
What is Investment Appraisal?
Investment Appraisal is a technique used to evaluate planned investment by a business and measure its potential value to the business.
List three methods of Investment Appraisal.
- Payback period
- Average rate of return (ARR)
- Discounted Cash Flow (DCF)
What does the payback period measure?
The time it takes for the project to pay back the initial outlay.
How is the month of payback calculated?
Month of Payback = Income needed in period / Contribution per month
What is one advantage of the payback period?
Easy to calculate and simple to use.
What is one disadvantage of the payback period?
Ignores what happens after the payback period.
Define Average Rate of Return (ARR).
An investment appraisal technique which calculates the average annual profit of an investment project, expressed as a percentage of the sum of money invested.
How is ARR calculated?
ARR = (Average Annual Return / Initial Outlay) * 100
What is one advantage of the Average Rate of Return?
Uses all the cash flows over the life of the project.
What is one disadvantage of the Average Rate of Return?
Ignores timings of the cash flows.
What does the Discounted Cash Flow method consider?
The time value of money.
What is Net Present Value (NPV)?
The value of future money if you had it now, considering inflation and potential for earning interest.
What is one advantage of Net Present Value?
Allows for future earnings to be adjusted to present values.
What is one disadvantage of Net Present Value?
Complex to calculate.
What internal business considerations should be evaluated when investing?
- Does the investment match the strategy and objectives of the business?
- Impact on staff
- Impact on existing products
List two external economic environment factors to consider when investing.
- The state of the economy
- Action of competitors
True or False: The availability of new technology can encourage further investment.
True
Fill in the blank: The initial outlay in the Average Rate of Return calculation refers to the _______.
[sum of money invested]
