Week 11- Investment Appraisal Techniques

Question 1

How do you work out ARR (Average rate of return)?

Answer 1

Average annual operating profit (x 100)| average amount invested in the project.

Question 2

What are the limitations of ARR?

Answer 2

It takes no account of the timing of cash flows
It ignores the time value of money
It takes no account of the actual size of a project

Question 3

What is the payback period?

Answer 3

The payback period is the length of time that the cash inflows form a project will take to cover the initial investment

Question 4

What are the limitations of the payback period?

Answer 4

Ignores cash flows after the payback period
Ignores the actual timing of cash flows
Takes no account of the tine value of money

Question 5

What is present value (PV)?

Answer 5

This is the value today of an amount that will be received in the future

Question 6

What does the net present value (NPV) mean?

Answer 6

It is an investment appraisal technique that calculates the PVs of all the cash flows associated with a project and by totalling them, arrives at the overall net present value.

Question 7

What does internal rate of return mean?

Answer 7

This is the discount rate that, when applied to a projects cash flows, will yield an NPV of zero.