Project Appraisal Flashcards
5 project appraisal methods
Payback method/period
Accounting rate of return
Net present value
Internal rate of return
Discounted payback period
3 discounted methods
Net present value
Internal rate of return
Discounted payback period
2 non-discounted methods
Payback method/period
Accounting rate of return
How to calculate payback period (payback method)
Time (number of years) for a project to recover the original investment - based on expected cash flows
How to calculate using NPV method
PV of cash outflows
How to calculate using ARR method
Average annual profits
/
Average capital investment
x100%
How to calculate discounted payback period
Time period required for break even factoring in time value of money
How to calculate using IRR method
Interpolation - with a positive NPV and negative NPV - calculate where 0 NPV would fall
How to calculate present value
Future value
/
(1 + rate of interest)^ n years
What is best according to payback method
Quickest payback
What is best according to ARR method
ARR must be higher than target rate of return, highest is best
What is best according to NPV method
Project must have positive NPV, if multiple, highest is best
What is best according to IRR method
Best differential with Cost of Capital
What is best according to discounted payback method
Quickest payback
4 advantages of payback method
Cash flows are used, not profits
Simple to calculate
Encourages quick return
Maximises liquidity
3 disadvantages of payback method
Ignores cash flows after payback period
Ignores the time value of money
Ignores profitability
3 advantages of ARR method
Simple to calculate
Focuses on profitability for entire period
Easy to compare with other projects
4 disadvantages of ARR method
Factors such as project life are ignored
Time value of money not considered
Different variations are possible (before or after tax)
Ignores profits reinvested during profit period
4 advantages of NPV method
Theoretically superior to all other methods
Considers time value of money
Based on cash flows, not profits (which vary on policy)
Takes all cash flows into account
3 disadvantages of NPV method
Difficult to explain to managers
Calculation can be challenging and requires knowledge
Relatively complex compared to non-discounting methods
4 advantages of IRR method
Cash flows rather than profits
Accounts for time value
Giver percentage rate comparable to target
Easier to understand than NPV
4 disadvantages of IRR method
Ignores factors including project duration and size of investment
Not a measure in absolute terms - estimation
Most complex to calculate - spreadsheet needed for accuracy
May not lead to maximisation of profits when there is capital rationing
3 advantages of discounted payback method
Considers time value
Uses cash flows
Determines recoverability of investment
3 disadvantages of discounted payback method
Requires an estimate of the cost of capital
Ignores cash flows beyond discounted payback period
Complex calculations if multiple negative cash flows
