BUSS3 - Finance - Investment Appraisal

Summary of what each investment method shows and the advantages and disadvantages of each method

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  • Investment Appraisal
    • Payback
      • Payback calculates how long it will take to pay back the cost of an initial investment. 
        • It shows how many years and month it will take to pay back
        • The shorter the pay back the better for the business as they are recieveing ti earlier.
      • Advantages
        • Guides the business and is easy to use
        • Benefits new business' who want to know the time frame in which their investment will be paid back
      • Disadvantages
        • Doesn't tell us what happens after pay back
        • Doesn't deal with time value of money
    • Average Rate Of Return
      • Average Rate Of Return Calculates the total return divided by the expected lifetime of the investment. It is shown as a percentage. 
      • Average Rate Of Return needs to be more than interest paid in order to be worthwhile
      • Advantages
        • Results can be easy to compare and are easily understood
        • Shows profitability of a project
      • Disadvantages
        • Harder and more time consuming to do
        • Doesn't consider time value of money
    • Net Present Value -
      • Net Present Value calculates the total return on an investment taking into account the time value of money when all current costs have been converted into their current worth. 
      • It discounts each years return because £1 now wont be the same in 5 years
      • A positive NPV means a worthwhile investment
      • Advantages
        • Only method that considers time value of money therefore more accurate
        • More precise answer
      • Disadvantages
        • Time consuming
        • Difficult to understand

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