Investment Appraisal (A Level) (Cambridge (CIE) A Level Business): Flashcards
Exam code: 9609
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Define investment appraisal.
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Cards in this collection (26)
Define investment appraisal.
Investment appraisal involves comparing the expected future cash flows of an investment with the initial expenditure on that investment.
What key data must be collected before an investment can be appraised?
A business needs sales forecasts, fixed and variable cost data, pricing information and borrowing costs.
How is the payback period calculated?
The payback period is calculated using this formula:
Payback period = initial outlay ÷ net cash flow per period
An investment costs $200,000 and generates net cash flow of $30,000 per year. What is the payback period?
The payback period is 6.67 years, which is 6 years and 8 months.
True or False?
The payback period shows how profitable an investment will be.
False.
Payback gives no insight into profitability. It only shows the time taken to recover the investment.
Why is the payback method useful when new technology is introduced regularly?
A business can check whether equipment pays back before an upgrade is available.
How is the average rate of return calculated?
The average rate of return (ARR) is calculated using this formula:
ARR = ((total returns − capital cost) ÷ years of use) ÷ capital cost × 100
True or False?
The average rate of return ignores the timing of an investment's cash flows.
True.
ARR is based on an average of the cash flows, so it ignores when they occur.
What two effects does net present value take into account?
Net present value takes into account the effects of interest rates and time.
NPV recognises the ______________ of not having the money available for other uses.
NPV recognises the opportunity cost of not having the money available for other uses.
How is the net present value of an investment calculated?
Each year's net cash flow is multiplied by a discount factor from a discount table. The initial investment is deducted from the total of the discounted cash flows.
What does a positive NPV indicate?
The project is expected to earn more than it costs, so it should be accepted unless qualitative factors suggest otherwise.
True or False?
Choosing a higher discount rate makes future cash inflows seem larger.
False.
A higher discount rate makes future cash inflows seem smaller, so the chosen rate strongly affects the NPV.
What is a typical NPV criterion for accepting an investment project?
A business may accept only projects with a positive NPV, sometimes above a set minimum, to ensure they add value.
How might a business use the average rate of return as an investment criterion?
It compares the return with other uses of the money, such as an interest-paying account, and may set a minimum ARR that projects must reach.
True or False?
Using quantitative methods makes comparisons between investment projects more objective.
True.
Quantitative methods make comparisons more objective and data-driven, and they help reduce risk by avoiding unprofitable investments.
What is the main limitation of relying only on quantitative methods in investment decisions?
They focus on financial results and leave out non-financial factors, such as environmental impact, employee wellbeing or customer satisfaction.
Non-financial factors that affect investment decisions, such as stakeholder impact, are known as _________ factors.
Non-financial factors that affect investment decisions, such as stakeholder impact, are known as qualitative factors.
Why should an investment align with business aims and objectives?
The investment should support the business's mission and long-term goals, such as growth, sustainability or social impact.
How can environmental impact affect an investment decision?
Projects that harm the environment may damage reputation or go against ethical values, while green projects support sustainability.
True or False?
All businesses are equally willing to take on risky investments.
False.
Risk tolerance varies with a business's size, finances and confidence in the market.
When is the payback period the most appropriate method of investment appraisal?
Payback suits a business that values speed of repayment and wants to reduce risk, especially in uncertain markets.
The payback period ignores total ___________ and the cash flows that arrive after payback.
The payback period ignores total profitability and the cash flows that arrive after payback.
When is the average rate of return a useful appraisal method?
ARR is useful for comparing profitability between projects, and it is simple for non-financial managers to understand.
Why is NPV the best method for large or long-term investments?
NPV takes account of risk and the time value of money, which matter most over long periods.
What are the limitations of NPV as an appraisal method?
NPV is more complex to calculate, its results depend on the chosen discount rate and it may be harder to explain to stakeholders.
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