Theme 3.3.2 Investment Appraisal Flashcards
1
Q
What is meant by the Average Rate of Return (ARR)?
A
ARR is a method of investment appraisal which measures net return per annum as a percentage of the initial spending
2
Q
What are the 3 steps used to calculate the Average Rate of Return?
A
- Calculate total profit over lifetime (total net cash flow minus the investment outlay)
- Divide by the no. of years of the investment project to give the average annual profit
- Apply the ARR
3
Q
What are the strengths of the ARR as a method of investment appraisal?
A
- measures profitability
- easy to compare % returns against other investments
- considers total revenue
4
Q
What are the weaknesses of the ARR as a method of investment appraisal?
A
- ignores timings of cash flows
- ignores the time value of money
- ignores the risk factor of having a long payback period (payback = the length of time that it takes for an investment to pay for itself from the net returns provided by that particular investment
5
Q
What is meant by Net Present Value (NPV)?
A
NPV is the present value of future income from an investment appraisal, less (minus) the cost
6
Q
What are the strengths of the NPV as a method of investment appraisal?
A
- considers all cash inflows
- use of discounting reduces the impact of long-term, less likely cash flows
- has a decision-making mechanism
- reject projects with negative NPV
7
Q
What are the weaknesses of the NPV as a method of investment appraisal?
A
- complex to calculate
- cannot compare projects with different initial costs
- rate of discount is critical - if it is high, fewer projects will be profitable
8
Q
Non-financial factors affecting investment decisions
A
- improving staff morale, making it easier to recruit and retain employees
- improving relationships with suppliers and customers
- improving your business reputation and relationships with the local community e.g. don’t male an investment that may be detrimental for the environment
