Investment Appraisal Assessment return

How much do you want your A-Level?  On a scale of 1 to 5  Where would you place your commitment to learning, since Sept 09?  1 = very determined, read over topics & extra reading  3 = will do ‘enough’ work to get by  5 = c’est la vie! I attend the lessons (most of the time!), what more do I need to do?! My views on you!

My judgement on you after ½ a term! Somehow, I think many of you will not like this! However, if you carry on ‘cruising’ half heartedly for the next ½ term – you will not achieve your potential! I don’t do excuses, only action – so start to prove me wrong!

You need your Planners – turn to the back section on targets…  Fill in Business Studies  Write in Mrs Gordon in one section & Mr Montana in the other  On your scripts – you will find an Attainment and a Target level…  You will also find at least ONE (T) with a comment!  1 = A/B  2 = B/C  3 = C/D  4 = D/E  5 = E/U  The (T) is my feedback on how you could improve!

The assessment answers My advice – make some notes!

1) Payback for each project (3 marks)  Project A  10,000 = 1, ,000 +3, (3,000/12 = 250 * 4 to get the extra 1000)  4 YEARS AND 4 MONTHS  Project B  10,000 = 4, , ,000  3 YEARS  Project C  10,000 = 3, , ,000 + (3,000/12 = 250 * 4 to get the extra 1000)  3 YEARS AND 4 MONTHS 1 mark per calculation/correct answer

ARR Formula – you need to know this! ARR = Total cash return – Initial cost = X X / no. of years = Y Y / initial cost x 100 = ARR % ARR = Total cash return – Initial cost = X X / no. of years = Y Y / initial cost x 100 = ARR % You need to learn this formula!

2) AVERAGE RATE OF RETURN (6 marks)  Project A  15,400 – 10,000 = 5,400/6 years = 900  900/10,000 * 100 = 9%  Project B  12,000 – 10,000 = 2,000/4 years = 500  500/10,000*100 = 5%  Project C  15,000 – 10,000 = 5,000 / 6 years  833/10,000 *100 = 8.3% 2 marks per correct answer 1 for 1 st line and 1 for 2 nd line (must be as a % final answer! 2 marks per correct answer 1 for 1 st line and 1 for 2 nd line (must be as a % final answer!

3) NPV (6 marks) For FULL MARKS… must identify difference … lower table. If missing = 5 marks max Yeardiscount Project A Project B Project C 0 0 -£10, , ,0003,6403,0002, ,0001,6603,0002,4903,0002, ,0002,2503,0002,2503,0002, ,0002,0402,0001,3603,0002, ,0001,860 02,0001, ,4001,940 01, Totals£5,400 £624 £2,000 -£260 £5,000 £1,310

Accounts formulas  Your accounts are worth ¼ of this January exam results…  It’s great that some of you have revised for this assessment & knew how to calculate Investment Appraisal.  It’s extremely worrying that some of you could not be bothered! So well done For those of you who know all 3 Investment Appraisal calculations! Some of you have to seriously consider commitment to learning. Your A2 exam is in 12 weeks! There will be a lot to revise. You need to learn each Accounts section as you go along!

4) Using financial techniques, justify which project you would advise them to choose (10 marks) OFR rule Vital to add data to your answer rather than generalisations.

4) Using financial techniques, justify which project you would advise them to choose (10 marks) LevelApplication (3)Analysis (4)Evaluation (3) 3 3 marks: use of all 3 Inv appraisal techniques / figures compared 4 marks: compares each Invest Appraisal – looks at specific differences between calculations. 3 marks: a balanced decision made with full justification 2 2 marks: use of 2 Inv appraisal techniques / figures compared 2-3 marks: compares general differences between results 2 marks: a decision made with some justification 1 1 mark: use of 1 Inv appraisal technique/figures used 1 mark: an attempt at analysis of figures 1 mark: a decision made 0000 no decision made

The issues to consider  Option B has quickest payback 3 years but raises least return (260) and the lowest of ARR 5%.  Option A has the highest ARR 9% but takes 1 year longer to repay than B, but has a positive NPV £624. Does the extra year of repayments on £10m deduct any benefits gained over Option C?  Option C is THE BEST OPTION with the largest real return (£1310 NPV) – especially seen as a better bet if future is risky and it has 3yr & 4mth payback (4mth slower B but 12 months quicker than the A). It also has the 2 nd best ARR of 8.3% (which is only 0.7% lower than the best ARR)  Payback = once investment has been paid back then any future return = contribution towards profit (not profit in itself…..so what’s the difference???)

Some ‘old’ answers Qd  “once the discount rate has been taken into account, Project C makes the most money £11,310. This is due to the high amounts in the first few years, when the discount rate is at its lowest. Based on this return I would recommend Project C.”  This gained 3 out of a possible 10!  How can this be improved? Ap 1 An 1 Ev 1 Compare Payback Use comparisons of data How much more? Why not B or A?

Some of ‘old’ answers Qd  “ on the basis of the payback period, project B is the 1 st to payback, however, this is very closely followed by project C. Project A however has a reasonably large payback period spun out over 4 years.  Project C gives the best ARR with 8.3%. This is a good rate and is above that of banks. However, Project B is not very good at only 5% which is below the level of most banks.  Project C gives the most NPV so this is the best on this factor where Project B gives a negative return.  I would choose project C because although it does not have the quickest payback time or ARR is does give by far the best NPV. It is also not far behind the best in other factors”  This gained 7 out of a possible 10!  Ap=3/3 An = 2/4 E=2/3  How can this be improved? Ap 1 An 1 Ev 1 How vague!?? AN = Need to compare values Ap 2 Ap 3 An 2 Ev 2 AN = Need to compare values

Some of ‘old’ answers Qd  Globe gears should choose project C because it produces the highest NPV, it also has an ARR of 8.3% (which only 0.7% worse than project A) however, Project C has a payback of 3yr and 4 mth in comparison to Project A of 4 yr and 4 mth – a year quicker! This will mean that the bank will get their money back quicker, meaning that they can invest in other projects to make more money in the long run. Ap 1 An 1 Ev 1 Ap 2 Ap 3 An 2 An 3 Ev 2

5) Assess what other factors Globe Gear should take into consideration before making their final decision. (8 marks)

You often need to remind yourself exactly what each project is!  Project A = purchase of machine  Project B = promotional campaign  Project C = rationalization of production department.  Could include  SWOT & PEST  Refer back to Co objectives  IR & Exchange rates  State of the economy  What are their competitors doing  ST v LT consideration promo & machine are ST but rationalisation is more LT NOT to accept general issues around whether each project is needed in 1st place – as this would have been considered BEFORE the investment appraisal.

Some ‘old’ answers Qe  “rationalising the dept could leave the co without any extra capacity…. So that if a machine breaks down, the co still has the resources to work to its usual capacity. If they do not manage this, clients cannot trust them in the future to meet demands. If the co rationalises the dept it may affect this and damage the co.  This gained 3 out of a possible 8!  How can the evaluation mark be improved? K1 An1 Ev1

Some answers Qe  “ staff happiness and customer satisfaction”  No analysis and no evaluation, despite identifying two issues…..  How could he have developed these two points?  Why is it important to consider these factors? K1

6) Explain the limitations of using numerical models in Investment Appraisal (7 marks) LevelKnowledge (3)Analysis (4) 33 marks: 3 relevant factors considered 4 marks: full explanation provided of limitations 22 marks: more than 1 relevant factor identified 2-3 marks: satisfactory explanation provided of limitation(s) 11 mark: a relevant factor identified 1 mark: some explanation provided of a limitation 000

Issues around Limitations  Payback  Not a measure of profitability  Ignores what happens during payback period  Encourages ST view  ARR  Ignores timing of cashflow  Ignores opportunity cost of the money invested  NPV  Complex to calculate  Discount used relies on a ‘fixed’ IR period over a long period of time – unrealistic.  All  Set against a background of uncertainty – economy, IR’s  How to balance risk against potential rewards – all of which are uncertain  Reliability of data – who provides it, how is it gathered? What variables are taken into account?  Can’t just base decisions on quantitative data but must also consider qualitative factors – other stakeholders, environmental issues  The company must have a minimum set criteria for all projects to meet before accepted – who decides on this criteria – is it realistic?

Some of your answers Q6  “they are based purely on costs instead of what is most needed to the business as a whole. If external problems occur such as a recession, the figures won’t be valid any more.” An1 K1 K2  “it doesn’t take into account inflation in the market, the cost of breakdowns with the project.” K1 K2 So What?

Some answers Q6 they do not take into account interest rates and inflation they are only estimates! they ignore other important issues! there is no quantitative issues, market trends… So What?

So what now…

Another practice  This is your last chance until December revision.