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INVESTMENT APPRAISAL: The process of analyzing whether investment projects…
INVESTMENT APPRAISAL: The process of analyzing whether investment projects are worthwhile
Payback
DEF: the time it takes for a project to repay its investment
Payback occurs when the cumulative net cash flow = 0
FORMULA:
cost of the investment
———————————
EVALUATION:
Advantages:
quick & easy
Focuses on
cash
- which is
normally scarce
Emphasis
speed of return
- good for
markets
which
change rapidly
Straightforward
for
comparisons
Disadvantages:
Ignores
cash flows
which
arise
after the
payback
has been
reached
Take no account of "
time value of money
" or "
total return on investment
"
Ignores
qualitative
aspects of a decision
Average rate of return (ARR)
FORMULA:
*Average annual profit
100
initial investment**
Average annual profit =
Total
revenue
- Total
costs
Number of years
Total inflow - Total outflow
Number of years
EVALUATION:
Advantages:
looks at the whole
profitability
of the project - a
key
issue for
shareholders
Look at the
profitability
& the
total return
on a project
Can use to
set
a
target ARR
the project should
meet
Disadvantages:
Does
not
take into account
cash flows
– only
profits
Takes no account of
the time value of money
DEF: looks at the
total accounting return
for a project to see if it
meets the target return
Net present value (NPV) or Discounted cash flow (DCF)
DEF: Calculates the
monetary value now
of the project's
future cash flow
(eg) $ receive in the future is worth less than $ receive in the future due to inflation
FORMULA:
NPV = Sum of DCF
DCF = Discounting factor * Net cash flow
EVALUATION
Advantages
Use of
discounting
reduces
the
impact
of
long-term
ie. inflation & ,
less likely cash flows
Takes account of
time value of money
Disadvantages:
More
time-consuming & complicated
Difficult
to
select
the most
appropriate
discount factor
Need to consider
Level of risks:
the longer the project, & the greater the amount of costs, the higher the risk
Sensitivity analysis
a technique which allows the analysis of changes in assumptions used in forecasts
Functions:
Help to judge the level of risk in an investment project
Recognise that there is no such thing as an accurate forecasters
Considers one variable or assumption at a time
EVALUATION:
Advantages:
Identifies the most significant assumptions
Helps assess risk and prepare for a less-than-favourable scenario
Helps make the process of business forecasting more robust
Disadvantages:
Only tests one assumption at a time (many assumptions may be linked)
Only as good as the data on which forecasts are based
Accuracy of data: hard to predict cash inflows & outflows
Consider external influences
Other quantitative techniques (eg) decision trees, break-even, effects on capacity, c utilization & productivity
Qualitatives datas:
Personal preference of the owner
Effects on the image
Effect on CSR
Does it meet the corporate objectives?
Effect on moral/ motivation of the workers
Dỉuption caused by implementing change in the bus
annual net cash flow