3.8 Investment Appraisal

Question 1

Define Investment.

Answer 1

A business expenditure on fixed assets with the potential to generate future financial benefits.

Question 2

Define Investment appraisal.

Answer 2

A quantitative decision-making tool used to assess and justify the capital expenditure of a firm.

Question 3

Define Payback Period (PBP)

Answer 3

The amount of time it takes for a business to recover the initial cost of an investment project.

Measures the time it takes for an investment project to earn enough profit to recover the initial cost of the investment.

This allows the firm to see if they will recover the cost of a fixed asset before it needs to be replaced.

Question 4

Formula of Payback Period.

Answer 4

PBP = Cost of Investment / Annual net cash flow

Question 5

Analysing the PBP (a larger annual contribution/annual net cash flow means?) and (when is it considered desirable?)

Answer 5

The faster the payback period. It’s desirable if the PBP is short.

Question 6

Advantages of PBP

Question 7

Disadvantages of PBP

Question 8

What is Net Present Value (NPV)?

Answer 8

The difference between total present values of future net cash flow and the initial cost of the investment project.

Question 9

Formula of Present Value.

Answer 9

PV = Net Cash Flow x Discount Factor

Question 10

Define Present Value.

Answer 10

Shows that future inflows have less value than inflows today.