assessing investments 

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  • assessing investments
    • investment appraisal is how attractive an investment is for investors by looking at various different techniques.
      • average rate of return. compares net return with the level of profit. the net return is the income of the project minus costs including the investment. the higher the ARR the more favourable the project will appear.
        • ARR is expressed as a percentage and calculated by average net return / investment x100
          • the net cash flow divided by the years in the table give you the ARR
            • advantages of ARR it takes into account cash flow so the best decision can be made.
            • it ignores timing of the cash flows and ignores the time value of money
    • payback period - measures the length of time it takes for a project to pay back the initial investment
      • amount invested / annual net return = payback period
        • £2 million project that has a annual net return of 250,000 will reach payback in 8 years
          • advantages of payback shows how long its going to take to pay off investment and it shows if the business its going to be profitable in the long run.
          • disadvantages of payback it ignores cash flow and can often lead to the wrong decision to be made.
    • risk and opportunity cost both increase the longer you have to wait for money which means its worth less
      • this is because inflation changes the value of money so £100 now might be worth less in 2 weeks time. there is also an opportunity cost when waiting for money as you could use it to invest if you had the money straight away
        • discounting adjusts the value of future cash inflows to their present value.
          • its used by investors to value money. its done by multiplying the amount of money by a discount factor.
            • discount factors are always less than 1 because the value of money in the future is always less than now
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