Y12 IB BUSINESS Investment Appraisal

Payback period

The time it takes for an investment project to earn enough profit to repay the cost of the initial investment

2 ways to calculate PBP

PBP formula, cumulative cash flow method

PBP formula

capital cost/contribution per month

advantages of PBP

• simple and quick

• can be used to compare investment messages

• see how fast cash can be recouped

disadvantages of PBP

• may encourage short term approach

• unlikely to be consistent, demand prone to seasonal fluctuations

• focus on time rather than profit

average rate of return

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

advantages of ARR

• enables easy comparisons between different projects

• helps decision making

disadvantages of ARR

• ignores timing of cash inflows

• calculations are based on project’s useful lifespan which may be inaccurate

net present value

calculate the present value of a return on an investment