chapter 9 business appraisal Flashcards
(14 cards)
what is the payback period
its the time taken for the project to pay back its initial cost
advantages of payback period
- simple to use
- effective to use when technology is changing fast, in order to recover from investment as quick as possible
- helps manage cash flow
disadvantages of using payback period
- ignores the cash flow over the lifetime of the project
- ignores the total profitability, only focuses on the speed at which the initial investment is replayed
what is average rate of return
measures the average net return every year with the cost of the investment
formula for ARR
(average annual profit) / (initial cost)
advantages of ARR
- shows the profitability of the project
- includes the project cash flow
- easy to compare
disadvantages of ARR
- ignores timing
- doesn’t allow the the effect of inflation
what is discounted cash flow
is the method of investment appraisal that takes into account the time value of money by calculating the net present value (NPV)
formula for NPV
discount factor x net cash flow each year
discounted cash flow
formula for DCF
sum of all NPV - initial cost
advantage of NPV
takes into account the time value of money
qualitative factors affecting investment appraisal
- impact on staff
can they handle the change (can be trained)
there will be redundancies - does it match the objectives and aims of the business
- state of economy
- ethical considerations
- sufficient funding
benefits of discounted cash flow
- Allows for future earnings to be adjusted to present values
- Easy to compare projects
- Allows for impact of inflation
- Discounts can be changed to take into account the economic climate
- Allows for the effect of risk on estimated future cash flows
drawbacks of discounted cash flow
- It is difficult to calculate
- Discount factors could be incorrect which makes NPV inaccurate
- Difficult to set discount factors far into the future the longer it is the less reliable the discount factor
