13.2 Methods of appraisal

• Capital investment appraisal improves decision-making by providing a structured approach to analyze investment opportunities.

  True
• The Payback Method considers the time value of money.

  False
• The Discounted Payback Method takes into account the time value of money.


  True
• Match the appraisal method with its characteristic:

  Payback Method ↔️ Calculates time to recover initial investment from undiscounted cash flows

  Discounted Payback Method ↔️ Calculates time to recover initial investment from discounted cash flows
• The Discounted Payback Method considers the time value of money.


  True
• Match the advantages and disadvantages of ARR:

  Simple to calculate ↔️ Ignores time value of money

  Focuses on accounting profits ↔️ Ignores cash flows

  Considers project life ↔️ Arbitrary hurdle rate
• Capital investment appraisal is the process of evaluating potential long-term investments
• Capital investment appraisal aligns investments with the overall business strategy
• The Payback Method ignores cash flows after the payback
• To calculate the Discounted Payback Method, future cash inflows are discounted using an appropriate discount
• The Discounted Payback Method calculates the payback period using discounted cash inflows
• Steps to calculate the Discounted Payback Period:

  1️⃣ Discount future cash inflows using a discount rate

  2️⃣ Sum the discounted cash inflows

  3️⃣ Determine the time to recover initial investment
• The Accounting Rate of Return (ARR) ignores the time value of money.


  True
• Capital investment appraisal involves predicting future market conditions.


  True
• Match the advantages and disadvantages of the Payback Method:

  Simplicity ↔️ Ignores time value of money

  Liquidity focus ↔️ Ignores cash flows after payback

  Risk consideration ↔️ Arbitrary payback period
• The Discounted Payback Method uses the unrecovered cost at the start of the final year
• The formula for ARR is: (Average Annual Profit / Initial Investment) x 100
• Steps to calculate Net Present Value (NPV)

  1️⃣ Determine future cash flows

  2️⃣ Select a discount rate

  3️⃣ Calculate present value of each cash flow

  4️⃣ Sum all present values

  5️⃣ Subtract initial investment
• What is the Internal Rate of Return (IRR) expressed as?

  Percentage
• Which method ignores the time value of money?

  Accounting Rate of Return
• What does the Payback Method calculate?

  Time to recover investment
• The Discounted Payback Method considers the time value of money.


  True
• How does the Discounted Payback Method compare to the Payback Method in terms of accuracy?

  More accurate
• The Accounting Rate of Return (ARR) considers the time value of money.

  False
• The Net Present Value (NPV) method is highly sensitive to changes in the discount rate.


  True
• Projects with uneven cash flows can have multiple IRRs.


  True
• Rank the capital investment appraisal methods from simplest to most complex:

  1️⃣ Payback Method

  2️⃣ Accounting Rate of Return (ARR)

  3️⃣ Discounted Payback Method

  4️⃣ Net Present Value (NPV)

  5️⃣ Internal Rate of Return (IRR)
• What is one of the challenges of capital investment appraisal?

  Complexity
• What is one advantage of the Payback Method?

  Simplicity
• Steps to calculate the Discounted Payback Method

  1️⃣ Discount future cash inflows using a discount rate

  2️⃣ Sum the discounted cash inflows until the initial investment is recovered

  3️⃣ Determine the time to recover the initial investment
• The Discounted Payback Method is more accurate than the Payback Method.


  True
• What is the formula for the Accounting Rate of Return (ARR)?

  (Average Annual Profit / Initial Investment) x 100
• Capital investment appraisal helps businesses decide if they should invest in new projects
• The Payback Method ignores the time value of money
• Steps to calculate the Discounted Payback Period:

  1️⃣ Calculate discounted cash inflows

  2️⃣ Sum the discounted cash flows

  3️⃣ Determine the discounted payback period
• What is the Accounting Rate of Return (ARR) used for?

  Capital investment appraisal
• What is the main drawback of using ARR in capital investment appraisal?

  Ignores cash flows
• A positive NPV indicates the project is profitable
• The Payback Method focuses on liquidity and risk
• The Internal Rate of Return (IRR) may favor smaller projects over larger ones due to its focus on percentage returns.

  True