Introduction to Investment Appraisal

What is investment appraisal?

A technique used to evaluate planned investment by a business, and measure its potential value to the business.

What is an autonomous investment?

Investment for the replacement of worn out goods.

What is an induced investment?

New investment arising from expansion.

What are the 3 methods of investment appraisal?

• Payback

• Average rate of return (ARR)

• Discounted cash flow (DCF)

What are some qualitative factors affecting investment appraisal decisions?

• Impact on staff. Can staff handle the changes brought about by investment? Can staff be trained to use new technology? Will there be redundancies as a result of the investment?

• Impact on existing products. Will managers concentrate on new products/investment to the detriment of existing output?

• Does the investment match the strategy and objectives of the business?

• The state of the economy. Is the economy booming? Or is there a recession (which is likely to reduce demand) on the way?

• Action of competitors. Are they investing/improving their products?

• Does the investment have any ethical considerations? Would the investment damage the environment?

• Is there sufficient funding available to invest in the project? Would the investment put the business at risk by reducing cash flow or increasing borrowing?

• Availability of new technology. New technology is one of the main factors that encourage further investment.

• Confidence of managers. Optimistic managers are more likely to invest.

Another factor a company might consider is that they wish to continue with an existing supplier of new assets rather than changing to a new supplier that offers better deal.