1. A21 Business Studies (Investment Appraisal)
Measuring the potential success of capital investment projects

2. Reasons for Investment Appraisal
Can give advice to managers and help them make decisions on capital investment projects
Enables projects to be evaluated
Can compare competing projects
Decisions are based on financial criteria

3. Problems of Forecasting Cash Flow
The validity of future cash flow figures
Interpretation of the figures
Does not consider all aspects of the business
May not consider business objectives

4. Investment Appraisal
Payback
Average rate of return
Net present value

5. Payback The time it takes for an investment to repay the initial outlay
Month of payback
= Income required
Contribution per month

6. Payback Advantages Limitations
Works out how fast the cost of the investment can be paid back
Advantages
Limitations
Easy to understand
Simple to use
Good for screening projects
Indicates how long money is at risk
Does not take into account any cash flow after the payback period
Overall profitability of the investment is not considered
Does not consider the current value of the cash

7. = Average annual return *100
Average Rate of Return
Compares the average annual profit generated by an investment with the amount of money invested in it
ARR
= Average annual return *100
Initial outlay

8. Average Rate of Return Advantages Limitations
Takes into account all cash flows throughout the life of the investment
Gives an idea of cash flow and profitability
Does not consider when cash flows occur
Does not consider the value of the cash flows over time

9. Net Present Value
Payback and ARR assume that the timing of future cash flows is unimportant.
Net Present Value (NPV) takes into consideration the time value of money.
Future sums are discounted or reduced by a certain percentage (say 5%, 10% etc) to reflect their lower value.
Also known as Discounted Cash Flow (DCF).

10. Net Present Value Advantages Limitations
More realistic – considers the time value of money
Can consider various scenarios
Complex to calculate
Results are easy to misread
Discount rate used is critical

11. A21 Business Studies (Investment Appraisal)
Factors Influencing Investment Decisions
Management objectives
Capital available
Returns on net assets
Opportunity cost
Technology used
Length of investment
Risk
Qualitative /Quantitative