Investment appraisal

Question 1

What are some methods for investment appraisal?

Answer 1

Payback period
Rate of return
Net present value

Question 2

What is payback period?

Answer 2

Calculate how long it will take to pay back the initial investment.

Question 3

How do calculate payback period?

Answer 3

(Amount needed to pay back / Net cash flow the year the investment as been paid off) x 12

Question 4

What are the benefits of using payback period?

Answer 4

Easy to calculate
Straight forward decision
Focused on speed of return

Question 5

What are the drawbacks of using payback period?

Answer 5

Does not take into account of cash flow after payback
Does not look at profitability of investment
Does not account for future value of money

Question 6

What is average rate of return?

Answer 6

Calculate average return as a percentage of the cost of the original investment.

Question 7

How to calculate average rate of return?

Answer 7

Step 1: Calculate average annual return
Total net cash flow / Number of years
Step 2: Calculate a rate of return
Average annual return / Investment x 100

Question 8

What are the pros for average rate of return?

Answer 8

Easy comparison
Focus on overall profitability
Can compare interest rates

Question 9

What are the cons of average rate of return?

Answer 9

Ignores time value of money
Focuses on profit not cash flow
Ignores timings of returns
Forecasted and quantitative only method

Question 10

What is net present value?

Answer 10

It calculates the total return of an investment taking into account the time value of money.