Investment appraisal Details Flashcards
Formula for payback period
Steps to find the payback period
-Calculate the net cash flow for each year
-Calculate the cumulative net flow for each year
-Identify the year when the cumulative net flow turns positive(i.e. the year the investment was paid back)
-Find the amount left to pay(by adding the net cashflows of previous years)
-Calculate the payback period
Formula for net cash flow
Net cash flow = Cash inflow - Cash outflow
Formula for cumulative net flow
Cumulative net flow = Cumulative net flow in previous years + Net flow of current year
Limitations of using the payback period
-It ignores the long-term profitability of an investment(more desirable investments may be overlooked as they have longer payback periods)
-It assumes that future cash flows have the same value as those of today
Businesses generally prefer investments with a higher rate of return(T/F)
True
Formula for average rate of return
Steps to find the average rate of return
-Calculate the sum of the net cash flows(returns) over the lifetime of the investment minus the capital cost
-Divide the result from step 1 by the number of years in the project(this is the average annual return)
-Divide the result from step 2 by the initial investment ost of the project(i.e. the capital cost)
Why does a unit of money not have the same value forever?
Becasuse of inflation and interest rates
Formula for the present value of a future cash flow(for a single year)
Formula for net present value
Steps to find the net present value
-Discount the net cash flow in each year
-Find the net present value
If a business is prioritising profits, it may choose investments that have a shorter payback period, or higher average rate of return or net present value(T/F)
True
Qualitative factors that businesses may use to determine investments
-Product life cycle
-Boston Consulting Group(BCG) matrix
-STEEPLE analysis
-Product portfolio analysis
-Market research results
-The mission statement
Quantitative factors that businesses may use to determine investments
-Return on investment(ROI)
-Cost savings
-Break-even analysis
-Market share
-Financing
-Cash flow assumptions
