Investment appraisal 3.3.2

Question 1

What is investment appraisal?

Answer 1

Comparing the expected future cash flows with the initial outlay for the investment to see if it worthwhile.
- How soon
- How profitable

Question 2

Simple payback period

Answer 2

amount of time it is expected an investment will pay for itself

initial outlay/ net cash flow per period = years/months

Question 3

Advantages and disadvantages of payback

Answer 3

+ Simple and easy to calculate & easy to understand the results
+ Emphasises speed of return - focuses on cash flow
- Doesn’t look at overall returns
- Doesn’t adjust for time value of money

Question 4

Average Rate of Return

Answer 4

Total accounting return for a project

(total net profit / no years) / initial cost x 100

Question 5

Advantages and disadvantages of ARR

Answer 5

+ Considers total returns of project
+ Easy to compare to other projects
+ Shareholder friendly as it is profitability-focused
- doesn’t adjust for the time value of money
- does not look at the timing of payments

Question 6

Net present value

Answer 6

Calculates the monetary value now of a project’s future cash flows

cash flow x discount factor = present value

Question 7

Advantages and disadvantages of NPV`

Answer 7

+ Takes into account time value of money
+ easy to see of you should accept or reject project
- only as good as the forecasts of costs
- only as good as forecasts of interest rates and thus discount factor used