209-Investment appraisal Flashcards
(11 cards)
What is meant by investment appraisal?
A technique used to evaluate planned investment by a business and measure its planned financial value to the business
Payback formula
Number of full years then
Amount needed final year/amount getting in final year x12
How to calculate ARR?
1)Calculate the total profit. Total returns - initial cost
2)Divide this answer by the number of years
3)Divide this by the initial cost and times by 100
How to calculate NPV
Income x discount factor
Add each year together
Deduct cost of investment
(Any positive figure is good)
Advantages of using payback
(+) Simple to use
(+) Easy to calculate
(+) Effective to use when technology is changing at a fast rate, such as hi tech projects, in order to recover the cost of investment as quickly as possible
(+) Helps managing cash flow
Disadvantages of using payback
(-) Ignores flows of cash over the lifetime of the project
(-) Ignores total profitability, the focus is just on the speed to which the initial outlay is repaid
Advantages of using ARR
(+) Shows the profitability of the option/project
(+) Includes all the project’s cash flows
(+) Easy to compare different projects
(+) Allows comparison with costs of borrowing for investment
Drawbacks of using ARR
(-) Ignores the timing of the cash flow
(-) Does not allow for effects of inflation on values of future
cash flows
Advantages of using net present value
(+)Allows for future earnings to be adjusted to present values
(+) Easy to compare different projects
(+)Allows for impact of inflation on value of future cash flows
(+) Discounts can be changed to take into account changes in the economic and financial climate
(+) Allows for effect of risk on estimated future cash flows
Drawbacks of using net present value
(-) It is difficult to calculate
(-) Discount factors could be incorrect which makes the NPV inaccurate
(-) Difficult to set discount factors far into the future, the longer into the future we go the less reliable the discount factor
