Investment Appraisal

Investment appraisal definition + types

Carefully judging whether an investment is worth doing or not. types: NPV, payback period, IRR and ARR

NPV

Money Today is worth more than in the future, with NPV it helps business figure out if the value of their investment will worth more in the future or not.

Advantages of NPV

• Take into Account the value of Money

• Takes account of all the cashflow over the whole project

Disadvantage of NPV

• Complex calculation

• Concept not easily understood

• Choice of discount should reflect capital and project risks

PayBack period

How long does it take to earn back the money i have invested into a business, this method is quicker, simpler. However it does not consider the value of money, mostly focus on earning their money back.

Disadvantages of a Payback period

• ignores everything that happens after you break even,

• doesn't account for the time value of money.

Advantages of a Payback Period

• Easy to calculate

• Easy to explain and Understand

• Focusses on Liquidity

• Good for short lived projects

Account Rate Of Return ( ARR )

Calculates the average profit of the investment, expressed in percentage

ARR   =   Average annual profit    x     100

  Average investment to earn that profit

Disadvantages of (ARR)

Doesn’t consider the time value of money

focus on profits neglects cashflows

Doesnt take into account how long a business takes to recover the initial investment

Advantages of ( ARR)

Considers profitability over the full project life — unlike payback period which stops once you break even, ARR looks at the average profit across the entire investment period.

Useful for performance evaluation — since it uses accounting figures, it aligns well with how managers are often assessed (based on profit), making it a natural fit for internal decision-making.

Internal Rate of Return (IRR)

A discount rate in which a project net present value is equal to zero, balancing the income cash flows with the cash flow out put.

Qualitative factors on Investment Appraisal

Non - financial factors that affect investment decisions such as staff morale, they are usually ignored as they are hard to express them in numbers.