1. Investment Appraisal

2. What is an investment appraisal? Evaluating the profitability of an investment project There are 3 methods of quantitative investment appraisal which are: Payback period Average Rate of Return Net Present Value using discounted cash flows

3. Payback period

4. Example 1

5. Method: Payback Period

6. Method: Team B

7. Advantages & Disadvantages of using Payback Period AdvantagesDisadvantages Quick & easyNot profitable Short termLong term will be unprofitable Important for liquidity

8. Average Rate of Return (ARR)

9. Example - ARR

10. Advantages & Disadvantages of ARR AdvantagesDisadvantages Uses all cash flow years – unlike payback period Average = constant. In reality, cash flow maybe periodic/erratic Life-cycle of capitalUnreliable forecast especially distant future Easily understood if comparedForecasted cash flows have not been discounted Profitability objectives

11. Net Present Value Todays value of the estimated cash flows resulting from an investment Uses discounted cash flows Method: 1. Multiply discount factors by the cash flows. Cash flows in year 0 are never discounted as they are today’s values already 2. Add the discounted cash flows 3. Subtract the capital cost to give the NPV

12. Example – Net Present Value Team B To get the future value, multiply the present value($m) by the discounted rate(inflation) Then add all the future values = 79.308 = 79.31 (2dp) Subtract the initial cost of capital by the total of future values to give you the Net Present Value (NPV) NPV = $9.31m Year$m10% Interest Rate Future Value 1150.909113.64 2180.826414.88 3210.751315.78 4240.683016.39 5300.620918.63

13. Advantages & Disadvantages of Net Present Value AdvantagesDisadvantages Considers both timing and sizecomplex Varied discounts depending on economic conditions Interest rates are unpredictable Opportunity costs