Investment appraisal techniques

Question 1

The payback method

Answer 1

How many months it takes for cash inflows from an investment to equal cash outflows

GOOD quick, quick and simple
BAD doesnt take into account time value of money, doesnt take into account cash flows after return, cannot distinguish between projects with the same payback period, no clear decision rule

Question 2

ARR

Answer 2

ARR = ROI

= profits/capital x 100

ONLY ONE USING PROFITS

ARR = average annual accounting profit/initial investment * 100
OR
ARR = average annual accounting profit/average investment * 100 whereby average investment = 0.5(initial investment + final or scrap value)

GOOD quick and simple, familiar concept of % return, profits easily calc from financial statements, looks at entire project life (unlike payback), more easily understood, allows comparison between projects
BAD does not take into account timing of profits, based on profits and not cash flows (profits = easily manipulated - provisions, accruals, depn etc), no clear decision rule, ignores time value of money, doesnt take into account length of project, relative measure rather than absolute (doesnt take into account size of investment)

Question 3

Political risks

Answer 3

Political risk = the risk that political action will affect the position and value of a company

-quotas/tariff/barriers imposed by the government
-nationalisation of assets by the overseas government
-stability of the overseas government
-political + business ethics
-economic stability/inflation
-remittance restrictions
-special taxes
-regulations on overseas investors