Investment appraisal

Question 1

Payback period

Answer 1

The time it takes for a project to repay its initial investment

Question 2

Payback period equation

Answer 2

(CCF left when investment is relayed/
Net cash flow of the following year) x12

Question 3

Pros of paybackperiod

Answer 3

-Identifies projects that provide quick returns
-Easy to calculate & understand
-Ignores LT forecast, so it’s more accurate

Question 4

Cons of payback period

Answer 4

-No insight into profitability
-Ignores what happens after pay payback period
-Encourages short termism

Question 5

Average rate of return

Answer 5

Measures the average return on investment as a percentage of the initial investment

Question 6

Average rate of return equation

Answer 6

(Avereage annule profits/
Initial investment) x100

Question 7

Pros of ARR

Answer 7

-Focus on profitability
-Uses all cash flow over the project’s life
-Useful for LT investments

Question 8

Cons of ARR

Answer 8

-Assumes constant profits throughout the investment
-Data not as accurate as payback as includes later years

Question 9

Net present value

Answer 9

Takes interest rates into account by calculating the present value, discounting them based on interest rates foregone

Question 10

Interpreting NPV

Answer 10

-A positive[ve NPV mean project is worthwhile
-Negative NPV means they should reject projects

Question 11

Pros of NPV

Answer 11

-Takes timings and present values into account
-Takes opportunity cost of investment into account

Question 12

Cons of NPV

Answer 12

-Discpoint factors can be subjective
-May not be accurate

Question 13

Limitations of investment appraisal

Answer 13

All use cash flow forecast, which is potentially inaccurate
-Unexpected rises in costs, exchange rates affect cash flow
-New competitors & change in trends

Question 14

Factors afecting investment decisions

Answer 14

-Corporate objectives
-Company finances
-social responsibility
-Investment criteria, min financial targets