3.3 Flashcards
Correlation
Positive:
Two variables move in the same direction
Negative:
Two variables move in opposite directions
Zero/Non-existant:
No correlation between data
Payback period
Time it takes for a project to repay it’s initial investment
+ Simple/easy to calculate
+ Focuses on cash flow
+ Emphasis on speed of return, good for dynamic markets
+ Straight forward to compare
- Ignores cash flow once payback is reached
- No account for time value of money
- May encourage short term thinking
- Ignore qualitative aspect oof decision making
- Doesn’t create decision making for the investment
Payback period how to
Inflow - outflow = answer
Initial outflow - answer = net gain
Find the year where 0 is reached
Calculates difference between that year and previous
Divide Net gain of the year 0 is reached by the difference^
Times by 52 (one year) = Answer (%)
Average rate of return (ARR)
The total accounting return for a project to serif it meets the target return level
+ Simple to understand
+ Focus on overall profitability
+ Easy to compare
+ Uses all return by a project
- Ignores the timing of returns
- Focuses on profit not cash flow
- No adjustment for the time value of money
ARR how to
- Net cash flow times or divided by no of years
- Answer divided by cost of investment
- x100=answer
Discounted cash flow/ Net present value (NPV)
Net present value, calculates monetary value of the project’s future cash flow
+ Considers future cash flow
+ Reflects risk
+ Creates straight forwards decision
+ Different levels of risk can be accounted for by adjusting the discount rate
- Complicated compared to ARR and payback period
- Choosing discount rate can be difficult
- Result can be influenced by discount rate
Net present value how to
- Calculate net value (Inflows - outflows)
- Times each year by their discounted factor
- Add up the discounted values
- Takes investment from this value
Decision trees
Mathematical approach to making choices
+ Logical understand
+ Choices are considered at one time
+ Likely costs/revenue are considered
- Just an estimation
- Quantitive data only
- Values estimated are prone to bias (inaccurate)
- Doesn’t reduce risks
Expected value: Financial outcome is estimates
= (probability x ER) + (probability x ER)
Net Gain: Value to be gained from taking a certain choice or decision
= Expected value - cost of project
Critical path analysis
Current ratios: Does a business have sufficient funds to cover their debts over a 12 month period
Float: The duration of an activity can be delayed by
Critical Path: Sequence of project activities which add up to the longest overall duration. The critical path determines the shortest time possible to complete a project
+ Helps to reduce risks and costs
+ Provides business with project overview
+ Helps to plan and make decisions
+ Better allocation of resources
- May be inaccurate
- Doesn’t guarantee success
- Can be too complex to understand
- Project may not go to plan
Earliest start time/Latest finishing time
LST: LFT at end of net work - Duration of previous activity
EST: EST from previous activity + Duration of previous activity
Investment appraisal
Process of analysing if investment of a project is worthwhile
Delphi method
- Relies upon canal of experts chosen by business
- Experts answer questionnaire
- Anonymous summary of forecast is given
- Experts encouraged to revise results
- After several rounds, range of answers get smaller until there is one ‘correct’ answer left
+ Doesn’t require history
+ Can be applied to any decisions
- Expensive
- Assumes consensus can be reached
- Time consuming
Ways to make decisions
Evidence based:
Pro:
- Data helps reduce risks
- Helps for comparing
Con:
- Data collecting is time consuming
- Out of date/unreliable
Subjective:
Pro:
- Experienced managers can make good intrinsic decisions
Con:
- Always an element of risk with intrinsic decision making
Evidence and subjective decision making
Evidence: Business makes strategic decisions after analysing/evaluating relevant evidence/data
+ Data helps to reduce risks
- Data collecting is time consuming
- Could be out of date/unreliable
Subjective: Decisions are made subject to personal preferences usually by business owners/managers
+ More experienced managers can make good intrinsic decisions
- Always a certain element of risk
Moving average
A succession of averages derived from successive segments (typically of constant size and overlapping) of a series of values
