investment appraisal

what is investment appraisal?

a technique used to evaluate planned investments

What is a payback period?

The time it takes for an investment to cover its initial cost

Payback period formula

initial investment/ annual cash inflows

Decision rule for payback period method?

Shorter payback periods are preferred

What is Net Present Value?

difference between present value of cash inflow and outflows, considering the time value of money

Net Present Value Formula

cash flow x discount rate

Decision rule for Net Present value

positive NPV = good investment negative NPV = rejection

What is the Annual Rate of Return?

average annual profit expressed as a percentage of initial investment

Annual Rate of Return Formula

average annual profit/ initial investment x 100

Decision rule for ARR

Higher ARR is preferred

An advantage of Payback period method

easy to calculate

Disadvantage of Payback period method

ignores the time and value of money

Advantage of Net present value method

helps compare projects with different time frames

Disadvantage of Net present value method

complex to calculate

Advantage of Annual rate of return method

helps evaluate return in relation to investment cost

Disadvantage of Annual rate of return method

only considers average profit and not cash flow timing