1. ACCOUNTS AND FINANCE Investment Appraisal: Payback Period

2. What is investment? TASK: Write your own definition of ‘investment’ in your workbook. Provide at least 3 examples of investment.

3. Definition  Investment refers to the purchase of an asset with the potential to yield financial benefits  What’s ‘yield’? Yield: the rate of return

4. Investment Appraisal  The term that refers to the techniques used to calculate financial costs and benefits of an investment decision  Four main methods of investment appraisal: 1. Payback Period 2. Accounting Rate of Return 3. Discounted Cash Flow 4. Net Present Value

5. Payback Period  The payback period refers to the period of time to repay the cost of the initial investment  Calculation: initial investment ($) contribution per month ($) The amount you expect this investment to make each month (after maintenance/taxes/etc)

6. Let’s try it...  Calculation: initial investment ($) contribution per month ($)  Scenario: a firm thinks about buying a new truck. It will cost $10 000 to buy. After insurance, servicing, and running costs, it is anticipated that the truck will make the firm $6000 per year ($500 per month). We work the payment period out like this: $10 000 $500 PAYBACK PERIOD = 20mths

7. Is it worth it?  Firms will mostly only undertake investment projects if the payback period is relatively short.  That is, there is no point in investing in something if it will be obsolete before the payback period.

8. Advantages  Simple and quick  Good for firms who have cash flow problems; allows them to easily see when they will regain money  Firms can see if they will break-even on a purchase before it needs to be replaced  Different projects and their costs can be easily compared  Allows a firm to see what investment will get a good return for shareholders  Less room for error ad the assessment is only for short term

9. Disadvantages  May create a situation that encourages managers to only consider short term benefits when really they should be considering the long term benefits as well  Contribution per month is unlikely to remain constant, due to changes in demand pattern. This could result in the payback period being longer than first anticipated  Focuses on time rather than profit, and profit is the main aim of most businesses

10. MORE HOMEWORK: Complete Question 3.2.1 on page 351 of your textbook. Write your answers in your workbook using full sentences. HOMEWORK: Finish table of Payback Period Adv/Disadv

11. Homework Answers: a) Reasons could include: the potential for CFC to return healthy profits; CFC may have been undervalued at the time of purchase; Abramovich could simply be a big fan of the club, i.e. Personal interest. b) There is no guarantee that CFC would become profitable; Abramovich had spent a lot of his own money on the club; CFC were suffering from ‘huge financial losses’ so Abramovich is taking a risk by investing in such a business; the club was not estimated to break-even until some 7 years after Abramovich took over the business. c) Start with defining the payback period. It would inform Abramovich how long it would take (as an estimate) before his spending on the club would generate enough revenue to pay back the value of the investment; a shorter payback period would tend to reduce the risk of such an investment project. Ultimately, it acts as a decision-making tool for risk assessment.