Investment Appraisal

Question 1

How to work out ARR

Answer 1

1- calculate cash inflows
2- total inflows minus investment
3- calculate annual profit (profit divided by years)
4- calculate return on investment (average profit divided by cost of investment)

Question 2

Benefits of ARR

Answer 2

Tangible results
Easy to understand
Focus on profitability
Can compare different investment opportunities

Question 3

Drawbacks of ARR

Answer 3

Just a prediction
Ignores time value of money
Averages can be skewed
Doesn’t say exact lifetime of asset

Question 4

Benefits if payback

Answer 4

Easy to understand 
Specific to months
Can compare different options
Measure of risk
Focus on cash flow

Question 5

Drawbacks of payback

Answer 5

Ignores time value of money
Doesn’t take into account unforeseen costs
Doesn’t tell lifetime of the investment and there’s no measure of return
Ignores cash flow after the payback period

Question 6

Benefits of NPV

Answer 6

Looks at lifetime of the investment

Considers time value of money

Question 7

Drawbacks of NPV

Answer 7

The discount rates needs to change mid investment

Discount is only a prediction

Question 8

What is internal rate of return

Answer 8

Where you break even on the NPV (the year you break even)