Investment Appraisal Flashcards
What is payback method
A calculation to see when the investment will earn enough to cover its cost
What is the formula for payback
(Income required/ NCF for that year ) x12
Do a payback of :
What is average rate of return
Looks at profits arising from an investment proposal as a % of the initial cost
Advanatges of Payback
- Easy to calculate / understand
- Useful for a business with weak cashflow e.g may want a quick return
Disadvanatges of Payback
- Doesnt give an insight into profits
- Encourages a short termist approach
- Ignores what happens after the payback time
What is an advantage of ARR over Payback ?
ARR looks at cash flows past the payback period, payback doesnt
What is the formula for ARR
(Average Annual Return / Initial Investment ) x100
AAR = Sum of cash flows - initial investment / No of years
What is the formula for Average Annual Return
AAR = Sum of cash flows - initial investment / No of years
Do a ARR for:
ii
Advantages of ARR
- Clear focus on profitability
- Easy to compare with other measures of return, as its in a percentage e.g. interest rate
- Considers cash flows over the whole project period
Disadvantages of ARR
- Ignores the timing of the cash flows
- May use forecast data, which could prove to be inaccurate
What is net present value
(Discounted Cash flow)
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
Do a NPV of :
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
Advanatages of NPV
- Takes into account time value of money
Disadvantages of NPV
- Only comparable if the initial investment is the same
- Meaning is often misunderstood
- Complex to communicate the meaning
What does a decision tree do ?
Uses estimates and probabilites to calculate likely outcomes
Do a decision tree
Advanatges of using a desicion tree
- Easy to present data to a board of directors
- Forced to consider all approaches, good in a democratic business
- Using quantative data, putting logic behind data
Disadvanatages of using a decison tree
- Takes time and money to gathering the data, may be inaccurate (change with time) , may be some guesswork
- May be bias from the data collector, may want a certain outcome
- Ignores qualitatitve data considerations
What is a critical path analysis
A tool to help find the most efficiant way in which to complete a project
Do a critical path witht the EST, LFT and Floats
Advantages of Critical Path Analysis
- Simultaneous engineering, shortens the overall projects time > decreasing costs
- Can use JIT for the delivery of materials, better liquidity and avoids materials sitting around
- Diagram is useful in handling any unforeseen delays, e.g. allocating more resources to critical paths to ensure theyre on time
Disadvantages of critical path analysis
- Can make a false sense of security, lead to laziness
