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


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