3.3 decision making techniques Flashcards
(19 cards)
Why is forecasting important to a business
This information informs key decisions about production, marketing, recruitment and finance
What is investment appraisal
a series of techniques designed to assist a business in judging the desirability of investing in. particular projects
What are the 3 investment appraisal methods and what are they
Payback- calculates the length of time it takes for an investment to recoup its original cost
Average rate of return- calculates the annual average return over the life of the investment in order to compare to other alternatives
Net present value- Considers the future value of an investment by discounting the decreased future value of money
How to calculate payback
Cash flow - Cumulative cash flow / cash flow
Ads and dis of payback
Ads:
- Focuses on cash flows
- Can compare with other projects
Dis:
- Doesn’t take into account time value of money
- Doesn’t create a decision for the investment
- Ignores cash flows after payback has been reached
What is ARR
The annual percentage return on an investment project based on average returns earned by the project
How to calculate ARR
- Total profits - initial cost of investment / number of years = average annual profit
- average annual profit / initial cost of investment x 100 = ARR
Ads and dis of ARR
Ads:
- Easy to compare to ARR targets
- Focuses on overall profitability
Dis:
- Ignores the timings of returns
- Focuses on profits rather than cash flows
- Doesn’t adjust for time value of money
What is net present value
Calculates the monetary value now of a future projects cash flows
What is discounting
The method used to reduce the future value of cash flows to reflect the risk that may not happen
How to calculate NPV
Cash flow x discount factor
Ads and dis of NPV
Ads:
- considers all future cash flows
- creates a decision, positive NPV suggests project should go ahead
Dis:
- Most complicated method compared to Payback and ARR
- Choosing the discount rate may be hard, especially for long projects
What is a decision tree
A model that is uses estimates and probabilities to calculate likely outcomes
Helps to decide whether the net gain is worthwhile
Define critical path analysis
A project analysis and planning method that allows a project to be completed in the shortest amount of time
Why do businesses need to plan complex projects
As they involve significant risk and investment, this causes for needing to know the most efficient way of completing the project
What does CPA calculate
The earliest start time and latest finish time that each activity can start and finish without making the project longer
What is the float time
The duration an activity can be extended or postponed so that the project still finishes within the minimum time
Ads and dis of CPA
Ads:
- reduce the risks and costs of projects
- helps to plan and organise resources
- Can create decisions
Dis:
- reliability based on estimates
- Doesn’t guarantee success of project
- Too many activities can make the diagram complicated
