The process of analysing whether investment projects are worthwhile
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What are the three main methods of investment appraisal and what are they measured in?
Payback Period (time/days/years), Average Rate of Return (%), Discounted Cash Flow or Net Present Value (£)
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What is the payback period?
The payback period is the time it takes for a project to repay its initial investment
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What must you do to calculate the payback period?
Identify the net cash flows for each period and keep a running total of the cash flows
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What is the formula for payback period?
The year it stops being negative + the remainder left to payback from last year / the following years net cash return
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If you want to convert the figure into months what must you do?
Multiply it by 12
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If you want to convert the figure into weeks what must you do?
Multiply it by 52
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What are the benefits of using payback period?
It is simple and easy to calculate and undestand, it focuces on cash flow, emphasises the speed of return and is easy to compare with competing projects
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What are the drawbacks of using payback period?
Ignores cash flows after payback has been reached, may encourage short-term thinking, ignores qualitative aspects of a decision
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What is the Annual Average Return (ARR)?
It is the percentage return on an investment project based on average returns earned by the project
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How do you calculate ARR?
Calculate the average annual profit from the investment, divide this by the initial outlay and compare it with the target % rate set by the business
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What are the benefits of using ARR?
Simple to calculate and understand, focus on overall profitability of investment project, easy to compare with other rates and uses all the returns generated by a project
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What are the drawbacks of using ARR?
Ignores the timing of returns, focuses on profits rather than cash flows
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What is Net Present Value (NPV)?
It calculates the monetary value now of a project's future cash flows
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What is discounting?
Discounting is the method used to reduce the future value of cash flows to reflect the risk that may happen
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What does 'time value for money' mean?
The idea that it is better to receive cash now rathe than in the future as future cash flows are worth less
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How do you calculate present value?
Cash Flow X Discount Factor = Present Value
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How do you calculate the NPV of an investment project?
Add together all the present values of future cash flows to calculate NPV
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What are the benefits of NPV?
Considers all future cash flows and their risks and creates a straightfoward decision
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What are the drawbacks of NPV?
Choosing the discount is hard as external factors such as Rates of Interest are hard to predict,
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What is sensitivity analysis?
A technique which allows the analysis of changes in assumptions used in forecasts
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Other cards in this set
Card 2
Front
What are the three main methods of investment appraisal and what are they measured in?
Back
Payback Period (time/days/years), Average Rate of Return (%), Discounted Cash Flow or Net Present Value (£)
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