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investment appraisal (investment decision making (analyse (Financial…
investment appraisal
investment decision making
proposal
scan environment for potential opportunities, ideas from management, consistent with organization overall strategy
screen
purpose for project, fit with organization long term objectives, resources & risks
analyse
Financial analysis
org's preffered investment appraisal techniques
qualitative analysis
staff morale, company image
monitor
capital expenditure does not exceed amount authorised
implementation not delayed
payback period (breakeven analysis)
time it takes for a project to recover its initial cost out of the cash receipts that it generates
=investment required/net annual cash inflow
criticisms
ignores the time value of money
ignores cashflow after the payback period
strengths
serves as a screening tool
identifies investment that recoup cash investment quickly
identifies products that recoup initial investment quickly
capital investment appraisal techniques
Discounting
Net Present Value
internal rate of return
non-discounting
payback
accounting rate of return
compounding
gives the future value of money
functions
time
interest rate
amount invested
Accounting rate of return (ARR)
looks at a single project in terms of return rather than the whole organisation
accepts projects with ARR greater than the cost of capital for the business
advantages
easy to calculate
needed information will usually be available
easy to understand
disadvantages
not a true rate of return
ignores time value of money
based on accounting books, not cashflow & market values
discounting
gives the present value of a sum received at a time in the future
NPV
a measure of how much value is created or added by undertaking an investment
advantages
takes into account net cash flows
includes time value of money
based on value addition
easy concept to understand
disadvantages
requires future cash inflows estimates
requires some basic financial management skills
internal rate of return
an investment is acceptable if the IRR exceeds the required return(cost of capital)
advantages
closely related to NPV
easy to understand and communicate
relates to an internal rate relative to a particular project
disadvantages
based on trial and error unless computer calculator is used
may result in multiple answers if cashflows are not conventional