3.3.2 investment appraisal

investment appraisal

a series of techniques designed to assist businesses in judging the desirability of investing in particular projects

3 financial methods to invest a large sum of money

simple pay back

average rate of return

discounted cash flow

when are these methods used

training/ retaining workforce

new products or brands

expansion

infrastructure

promotional campaigns

new technology

why is it used for planning

determines whether long term investments will give the best return

why is it used for decision making

it will help work out which project should have the fundings

payback

the time it takes for a project to make enough money to pay back the initial investment

payback=

amount of investment/ revenue generated x12

payback benefits

simple to calculate, good for products such as technology wanting money back quickly

payback drawbacks

ignores level of profit and cash flow, ignores timings of receipts, ignores time value of money

average rate of return ARR

compares the net return with the level of investment

average rate of return=

average net return/ investment x100

average net return=

cashflows-investment/no. of years

average rate of return benefits

simple to calculate, takes into account all of the cashflows

discounted cash flow NPV

took that takes into account the time value of money. adjusts the value of cashflows in the future to calculate the present value

discounted cash flow NPV=

year value x discount value

added discount cashflow- original value= NPV

discounted cashflow NPV benefits

takes into account the opportunity cost of the investment, considers the inflows and outflows

discounted cashflow NPV drawbacks

harder to calculate, hard to work out what discount factor should be, longer projects are harder to predict