Investment Appraisal

Question 1

Name 2 benefits of payback

Answer 1

1. Simple and easy to calculate

2. Focuses on cash which is normally scarce

Question 2

Name 2 drawbacks of payback

Answer 2

1. Doesn’t show the ease/difficulty of borrowing
2. Doesn’t tell you how long the investment will last
3. Based on assumptions

Question 3

What is accounting rate of return (ARR)

Answer 3

A calculation to work out the percentage yearly return of an investment

Question 4

What is the 3 step calculation to work out ARR

Answer 4

1. Profit / number of years
2. ANS / investment (cost)
3. ANS x 100 = % yearly return

Question 5

Name 2 benefits of ARR

Answer 5

1. % return can be compared to target % return

2. It focuses on profitability which is key for shareholders

Question 6

Name 2 drawbacks of ARR

Answer 6

1. Doesn’t take into account cash flow only profits
2. Doesn’t look at the changing value of money due to inflation
3. Treats profits rising late into investment the same as ones rising early in investment when there are different needs

Question 7

Define investment appraisal

Answer 7

Assessing whether investment projects are worthwhile

Question 8

Define payback period

Answer 8

Payback period is the time it takes for a project to repay its initial investment