Investment appraisal
- Created by: noe
- Created on: 20-09-20 13:30
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- Investment appraisal
- Investment: purchase of capital goods used in the production of other goods repeatedly over a period of time
- Investment: expenditure on projects now in the hope that a greater amount of money will be generated in the future
- Investment appraisal: the evaluation of an investment project to determine whether or not it is likely to be worthwhile and to compare between different projects
- Capital cost: amount of money spent when setting up a new venture
- Net cash flow= cash inflows- cash outflows
- Simple payback: amount of time it takes for a project to recover or pay back the initial outlay
- Cumulative cash flow: the net cash flow each year, taking into account the initial cost of investment (total initial cost + net cash flow)
- Advantages
- Simple
- Useful if business has cash flow problems as the project chosen will 'pay back' quicker
- Useful when technology changes rapidly as it's important to recover the cost of investment before a new model/ equipment is designed
- Drawbacks
- Cash earned after payback is ignored
- Profitability overlooked
- Average (accounting) rate of return (ARR)
- Method used to measure net return each year as a percentage of the capital cost of the investment
- Net return (profit) per annum/ capital outlay (cost)*100
- Net profit per annum calculated by subtracting its capital cost from the expected net cash flow of the project and dividing by number of years the project runs for
- Advantages
- Clearly shows the profitability of an investment project
- Overall rate of return can be compared to other uses for investment funds
- Easier to identify the opportunity cost of investment
- Drawbacks
- Effects of time on the value money ignored
- Investment: purchase of capital goods used in the production of other goods repeatedly over a period of time
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