INVESTING APPRAISAL - NET PRESENT VALUE Flashcards
What is investment appraisal
Investment appraisal = Businesses spending money on something trying to workout if that investment is going to be financially viable - For example a business may want to see if it would be a good financial decision for it to: expand overseas, invest in a marketing campaign, open a new factory etc
What are methods of investment apprasal
Payback - calculates when the initial investment will be paid back
ARR (average rate of return) - calculates the lifetime profitability of a project
Net present value - combines an assessment of the timing of cash flows and overall profitability
What does net present value (NPV) calculate?
Net present value (NPV) calculates the value of the expected returns of a project in today’s terms.
What happens to the value of money when more money is printed
The combined impact of lost interest and inflation mean that money today will buy more than the some amount of money in the future (the more money that’s made the less valuable a currency becomes)
What are the 2 steps involved in calculating NPV
Multiplying the net cash flow by the relevant discount figure
Add up the NPV to give the total return on the investment
How to calculate NPV
- Multiply the net cash flow by the relevant discount figure
- Add up the NPV to give the total return on the investment
What are other key things to understanding NPV
A positive figure indicated the investment will be profitable
A project that brings in more cash in the near future is likely to be more valuable
A number of calculations could be undertaken to consider the impact of changes in the interest rate
What are the pros of NPV
Taking the opportunity cost of keeping money in a bank into account
Considerd both the timing and profitability of a project
Can be used to consider different scenarios
What are the cons of NPV
Uncertainty about the discount rate to use. Interest rates and inflation change over time
Time consuming to calculate
