management accounting - investment appraisal

Question 1

explain the nature and purpose of investment appraisal

Answer 1

the process of analysing whether investment projects are worthwhile and to make a decision on whether to carry out the investment or not

Question 2

what are the 3 types of investment appraisal?

Answer 2

• payback period
• average rate of return
• Net present value

Question 3

how to calculate payback period?

Answer 3

investment + year 1
new value + year 2
continue until the next year will be paid back

to find the months:
value of year before paid back/value of year after
that value x 12
then round up

Question 4

benefits of payback period?

Answer 4

• focuses on cashflow not profit
• easy to compare projects and decide which one is worth investing in
• emphasises speed of return; good for markets which change rapidly

Question 5

drawbacks of payback period?

Answer 5

• ignores cashflow after payback period has been reached
• takes no account of “the time value of money” i.e. inflation

Question 6

what is average rate of return?

Answer 6

looks at the average return for a project to see if it meets the targeted return

Question 7

how to calculate ARR?

Answer 7

1. add them up
2. subtract the investment
3. put into fraction:
   ((total net profit/years)/initial cost) x100

Question 8

what are the benefits of ARR?

Answer 8

• provides a % return which can be compared with target return
• looks at whole profitability of project (good for shareholders)

Question 9

drawbacks of ARR?

Answer 9

• doesn’t take into account cashflows
• takes no account for inflation (value of money changes overtime)

Question 10

what is net present value?

Answer 10

CHECK THIS LATER!!! used to determine whether or not an investment, project, or business will be profitable down the line

Question 11

how to calculate net present value?

Answer 11

1. projected net cashflow x discount rate
2. add them all up (ex. investment)
3. initial investment - total present value