Investment Appraisal

Question 1

Evaluate Payback (Benefits)

Answer 1

• Places emphasis on immediate cash flows which minimises risk
• Can be used on a single investment project or to compare different projects
• Easy to understand method that gives a clear result.
• Best used for businesses with limited resources

Question 2

Evaluate Payback (Drawbacks)

Answer 2

• Does not consider the time value of money as the Net Present Value method does.
• Gives different result from the Average rate of Return method as payback ignores returns made after the payback period.
• External Factors not considered
• Based on estimates/predictions
• Ignores Qualitative factors

Question 3

ARR (Benefits)

Answer 3

• Shows clearly to managers the profitability of an investment project. A % figure is shown which is easy to understand.
• Easy comparison with other projects
• Takes into account all figures, even money after payback

Question 4

ARR (Drawbacks)

Answer 4

• Time value of money is not taken into account.

- Compared to the likes of Payback, ARR is more complicated to calculate and may not be familiar to managers etc

Question 5

NPV (benefits)

Answer 5

• NPV takes the timing of cash flows into account meaning that more value is placed on earlier cash flows.
• NPV considers all the cash flows and not just up to the moment when the project pays for itself
• While the calculations required for NPV may be difficult to compute but once portrayed in a table, it is easy for decision-makers to understand.

Question 6

NPV (drawbacks)

Answer 6

• NPV requires more difficult calculations to be completed. (More expertise)
• Based on estimates (data may be inaccurate) (things could change)
• The discount factor chosen may have been realistic at the time the decision was made but may become completely unrealistic during the lifetime of the project.