Business Studies Unit 3 topic 3

Strategic & Tactical Decisions 

Investment Appraisal - or capital budgeting is the process of evaluating whether or not to invest in a project.

Investment - expenditure on capital goods; business invest in short term hoping it will increase profits in long term; invest whenever they buy fixed assets.

Methods: 

1. Payback method
2. Average rate of Return (A.R.R)
3. Net Present Value (N.P.V)

1. Payback Method time taken for project to recover initial cash invested; for companies focused on liquidity 

Advantages:

• Easy to calculate and understand
• Puts emphasis on liquidity - key element to healthy capital 
• Investment risk is increased id payback is longer due to future uncertainty; gives priority to shorter payback period to reduce risks

Disadvantages:

• Ignores cash generated after payback; may reject highly profitable projects
• Doesn't account for time value of money; interest rate
• Unable to give a decision for projects with the same payback period 

2. Average Rate of Return - compares profit/average annual return of an investment with the cost of investment

ARR = average annual returns profits ÷  initial cost of investment  x100

Advantages:

• Provides easy way to rank competing projects judging by their rate of return
• Possible to measure profitability of a project

Disadvantaged:

• Doesn't account for time value of money
• Doesn't consider time for recovery of initial investment 

3.) Net Present Value - accept projects with positive NPV; reject projects with negative NPV

NPV = sum of present value — initial cost

Advantages:

• Takes in account time value of money
• Takes into account all the cash flows over the life of investment

Disadvantages:

• Cash flows used in the calculations are mere estimates
• NPV’s cannot be compared where capital costs of projects are different

Decision Trees -  a technique of making decisions in conditions of uncertainty 

Advantages:

• Highlights decisions and every factor affecting it
• Forces management to consider every risk involved in decision making

Disadvantages:

• There is a time lag between making the decision and collecting information about the project
• Ignores qualitative aspects
• Data are mere estimates

Contribution - difference between selling price & various costs 

Critical Path Analysis (CPA) - project management tool that helps to manage the flow of activities and resources in a project to make sure it’s completed on time.

• Earliest Starting time (EST) - earliest starting time activity van be started without delaying a project
• Latest Finish time (LFT) - latest time an activity can be finished without delaying project completion 
• Float - amount of time an activity can be delayed by without delaying a project

Advantages:

• Plans a project in advance & shows what resources will need to be used and at what time
• Helps to identify critical and non-critical activities to ensure the project is completed on time 
• CPA ensures number and efficient use of resources
• Facilitates taking of correctional actions if performance falls before schedule 

Disadvantages:

• Highly depends on accuracy of the information used
• Requires time and costly expertise

Business Contingency planning - a back up to the original plan

Advantages:

• Minimises the effects of unforeseen risks by…