Investment Appraisals- Finance Flashcards
What are investment appraisals
The process of analysing whether a investment project is worthwhile.
What is Average Rate of Return (ARR)
Looks at the average return for a project to see if it meets the target return. Higher the better.
What are the steps for calculating ARR?
(Net flow - Initial Investment) / number of years
(Answer / initial investment) x 100
What are the advantages of businesses?
Provides a percentage return which can be compared with a target return
It looks at the whole profitability of the project
Focuses on profitability- key issue for shareholders
What is a Payback Period?
Its the time it takes for a project to repay its initial investment
How do you calculate the payback period?
What is left to be paid / cash flow of the next year
What is Net Present Value (NPV)?
Net Present Value calculares the monetary value of a project’s future cash flows.
How do you calculate Net Present Value?
Cashflow x Discount Value = Present Value
What are the advantages of a business using Net Present Value?
It takes into account the time value of money, placing emphasis on earlier cash flows
Looks at all the cash flows involved throughout the life of the project
Use of discounting reduces the impact of long-term, less likely cashflows.
What are the disadvantages of using Net Present Value?
More complicated methods so users might find it hard to understand
The calculation is very sensitive to the initial investment costs
Its difficult to select the most appropriate discount rate- may lead to good projects being rejected
Does not consider external factors
