investment appraisal

Question 1

What is investment appraisal?

Answer 1

Investment appraisal is a technique used to evaluate planned investment by a business, and measure it’s potential value to the business.

Question 2

What is payback period?

Answer 2

The time it takes for a project to repay its initial investment. Measured in time, days, years.

Question 3

Advantages of payback period

Answer 3

• Simple to use
• Easy to calculate
• Helps with managing cash flow

Question 4

Disadvantages of payback period

Answer 4

• Ignores flow of cash over the lifetime of the project
• Ignores total profitability, the focus is just on the speed at which the initial outlay is repaid.

Question 5

What is the calculation for payback period months?

Answer 5

Payback = Cumulative cash flow value (for last year figures/net cash flow for the next year x 12

(If decimal always round up)

Question 6

What is ARR?

Answer 6

Average or accounting rate of return – Looks at the total accounting return for a project to see if it meets the target return. Measured in %

Question 7

What is the calculation for ARR?

Answer 7

Average profit per annum/ Initial investment cost x 100

Question 8

What are the advantages of ARR?

Answer 8

• Shows profitability of a project
• Includes all the project’s cash flows
• Easy to compare with other projects

Question 9

What are the disadvantages of ARR?

Answer 9

• Ignores the timing of cash flow
• Does not allow for effects of inflation on values of future cash flows

Question 10

What is net present value?

Answer 10

Net present value calculates the money value now of a project’s future cash flows.
Measured in monetary values.

Question 11

How do you work out Net present value?

Answer 11

Use NFC column and multiply the NCF and value for each year by respective discount. Which will give you the present value and subtract the cost of the initial investment to calculate the net present value.
If result is positive then an investment decision is viable but a negative value suggests that an investment is not financially viable.

Question 12

Benefits of NPV

Answer 12

• It only one of the methods that takes into account the time value of money
• It allows the future earnings of a project to be put into a present value
• Discount factors can be changed to reflect different market conditions

Question 13

Drawbacks of NPV

Answer 13

• The further into the future the cash flow projections, the less accurate the data the discount factor will be
• It assumes that inflation to be constant, unrealistic
• It is complex to conduct and difficult to interpret