3.8 - Investment Appraisal Lecture Notes

These flashcards cover key concepts related to investment appraisal, including methods, advantages and disadvantages, and factors influencing decision-making.

What is Investment Appraisal?

Investment appraisal refers to the quantitative (financial) and qualitative (non-financial) approaches to evaluate the costs and benefits of an investment decision.

Define Payback Period.

The payback period (PBP) refers to the time it takes for an investment project to earn enough profit to repay the cost of the initial investment.

What are the advantages of using the Payback Period method?

The simplest method, useful for firms with cash flow issues, allows for breaking even analysis before replacements, and compares different investment projects.

What are the disadvantages of using the Payback Period method?

Encourages a short-term investment approach, assumes constant monthly contributions, and focuses on time instead of profits.

What does the Average Rate of Return (ARR) calculate?

The average profit on an investment project as a percentage of the amount invested.

What are the advantages of using the Average Rate of Return?

Enables easy comparisons between projects and aids decision making.

What are the disadvantages of using the Average Rate of Return?

Ignores timing of cash inflows and is prone to forecasting errors.

What is Net Present Value (NPV)?

The net present value (NPV) method calculates the present value of the return on an investment.

What is a major disadvantage of using NPV?

Ignores timing of cash inflows and is subject to forecasting errors.

List the decision rules for investment appraisal methods.

Payback period: shorter is better; Average rate of return: higher is better; NPV: higher is better.

What factors should be considered in making investment appraisal decisions?

Profit-seeking vs ethical stance; risk-profile; corporate image; human relations; state of the economy.

How might an understanding of Hofstede's cultural dimensions assist managers in investment decision making?

It provides insights into cultural differences that affect managerial decision making and evaluation of investments.