investment appraisal - NPV, ARR, payback period

What is a benefit of ARR regarding its calculation?

ARR is easy to calculate.

What does ARR use to assess an investment?

ARR uses all the returns generated by the project.

How does ARR help in decision making?

It allows easy comparison with other target rates of return.

What is a major drawback of ARR concerning timing?

ARR ignores the timing of returns.

What aspect of returns does ARR primarily focus on?

ARR focuses on profits rather than cash flows.

What important financial concept does ARR not account for?

ARR does not account for the time-value of money.

What qualitative factor does ARR overlook in decision-making?

ARR ignores qualitative aspects of a decision.

What is the purpose of calculating payback in investment appraisal?

To determine how long it takes for an investment to repay its initial cost.

What does the average rate of return measure in investment appraisal?

It looks at the total accounting return for a project to see if it meets the target return.

How is the average rate of return expressed?

As an annual percentage return on an investment project based on average returns earned by the project.

How can businesses use the average rate of return?

To compare the % of the initial investment they will get back every year with interest rates from banks.

What was the cumulative cash flow at the end of year 1 given initial cash outflow was (500,000) and cash inflow was 220,000?

(500,000) + 220,000 = (280,000).

What is the payback period?

The time it takes for a project to repay its initial investment, measured in years and months.

What are the benefits of using the payback method?

Simple and easy to calculate, easy to understand, focuses on cash flow, emphasizes speed of return, and straightforward for comparing projects.

What is one major drawback of the payback method?

It ignores cash flows that occur after the payback period has been reached.

How does the payback method view the time value of money?

It takes no account of the time value of money.

Why might the payback method encourage short-term thinking?

Because it focuses on quick returns and does not consider long-term cash flows or qualitative aspects.

What type of cash flow is emphasized in the payback method?

Cash flows that occur before the payback period is reached.

What is the net cash flow in year 0 for the investment mentioned?

-500,000.

What is a potential consequence of ignoring qualitative aspects in decisions made using the payback method?

It may lead to poor long-term decision-making.

What are some non-financial factors to consider before making a financial decision?

Competitors' actions, interest rates, and inflation.

What does NPV stand for and why is it beneficial in financial decision making?

NPV stands for Net Present Value and it considers all future cash flows, reflects risk, and provides a straightforward decision-making process.

What is a drawback of using NPV in long-term projects?

Choosing the discount rate is challenging and can significantly impact the results.

How can different levels of risk be accounted for in NPV calculations?

By adjusting the discount rate.

What items are necessary to calculate net present value (NPV)?

Cash inflows and outflows, the cost of the investment, the number of years, and the discount factor.

What does NPV stand for in investment appraisal?

Net Present Value.

What does Net Present Value (NPV) calculate?

The monetary value now of the project's future cash flows.

What is the purpose of discounting in NPV calculations?

To reduce the future value of cash flows to reflect the risk that they may not happen.

In the NPV calculation, how do you find the present value of a future cash flow?

Multiply the cash flow by the discount factor.

If the Net Present Value is negative, what should the manager do?

Reject the investment.

What does a positive NPV indicate about the investment?

It should be accepted.

Which factors are considered when calculating NPV?

Future cash flows, discount rates, and cost of the investment.

What is the range of discount factors used in NPV calculations?

Between 0 and 1.

If a future cash flow is £17,000 at year 1, and the discount factor is 0.952, what is the present value?

£16,184.