Investment Appraisal

Question 1

What is payback method

Answer 1

A calculation to see when the investment will earn enough to cover its cost

Question 2

What is the formula for payback

Answer 2

(Income required/ NCF for that year ) x12

Question 3

Do a payback of :

Answer 3

Question 4

What is average rate of return

Answer 4

Looks at profits arising from an investment proposal as a % of the initial cost

Question 5

Advanatges of Payback

Answer 5

1. Easy to calculate / understand
2. Useful for a business with weak cashflow e.g may want a quick return

Question 6

Disadvanatges of Payback

Answer 6

1. Doesnt give an insight into profits
2. Encourages a short termist approach
3. Ignores what happens after the payback time

Question 7

What is an advantage of ARR over Payback ?

Answer 7

ARR looks at cash flows past the payback period, payback doesnt

Question 8

What is the formula for ARR

Answer 8

(Average Annual Return / Initial Investment ) x100

AAR = Sum of cash flows - initial investment / No of years

Question 9

What is the formula for Average Annual Return

Answer 9

AAR = Sum of cash flows - initial investment / No of years

Question 10

Do a ARR for:

Answer 10

ii

Question 11

Advantages of ARR

Answer 11

1. Clear focus on profitability
2. Easy to compare with other measures of return, as its in a percentage e.g. interest rate
3. Considers cash flows over the whole project period

Question 12

Disadvantages of ARR

Answer 12

1. Ignores the timing of the cash flows
2. May use forecast data, which could prove to be inaccurate

Question 13

What is net present value

(Discounted Cash flow)

Answer 13

Use a discount rate to show the value of money decreases over time

Can be compared to the interest that couldve been earned from putting into a bank

Question 14

Do a NPV of :

Answer 14

For 1: At the end of year 5 the value of the project is £11.4m

For 2: At the end of year 5, the value of the project is £0.1 m

>> Any result above 0 is worth doing

Question 15

Advanatages of NPV

Answer 15

1. Takes into account time value of money

Question 16

Disadvantages of NPV

Answer 16

1. Only comparable if the initial investment is the same
2. Meaning is often misunderstood
3. Complex to communicate the meaning

Question 17

What does a decision tree do ?

Answer 17

Uses estimates and probabilites to calculate likely outcomes

Question 18

Do a decision tree

Answer 18

Question 19

Advanatges of using a desicion tree

Answer 19

1. Easy to present data to a board of directors
2. Forced to consider all approaches, good in a democratic business
3. Using quantative data, putting logic behind data

Question 20

Disadvanatages of using a decison tree

Answer 20

1. Takes time and money to gathering the data, may be inaccurate (change with time) , may be some guesswork
2. May be bias from the data collector, may want a certain outcome
3. Ignores qualitatitve data considerations

Question 21

What is a critical path analysis

Answer 21

A tool to help find the most efficiant way in which to complete a project

Question 22

Do a critical path witht the EST, LFT and Floats

Answer 22

Question 23

Advantages of Critical Path Analysis

Answer 23

1. Simultaneous engineering, shortens the overall projects time > decreasing costs
2. Can use JIT for the delivery of materials, better liquidity and avoids materials sitting around
3. Diagram is useful in handling any unforeseen delays, e.g. allocating more resources to critical paths to ensure theyre on time

Question 24

Disadvantages of critical path analysis

Answer 24

1. Can make a false sense of security, lead to laziness