13.1 Understanding investment appraisal

• Investment appraisal helps businesses make informed capital investment decisions.

  True
• The accounting rate of return (ARR) calculates the average annual profit as a percentage of the initial investment
• Capital investment appraisal is the process of evaluating the potential profitability and feasibility
• Match the investment appraisal technique with its description:

  Payback period ↔️ Time to recover initial investment

  Accounting rate of return (ARR) ↔️ Profit as a percentage of investment

  Net present value (NPV) ↔️ Present value of future cash flows

  Internal rate of return (IRR) ↔️ Discount rate making NPV zero
• The time value of money concept states that money today is worth more than the same amount in the future
• Risk and uncertainty are important considerations in investment appraisal.


  True
• What is the primary purpose of capital investment appraisal?

  Evaluate investment profitability
• Arrange the main investment appraisal methods in order from simplest to most complex:

  1️⃣ Payback period

  2️⃣ Accounting rate of return (ARR)

  3️⃣ Net present value (NPV)

  4️⃣ Internal rate of return (IRR)
• What is the net present value (NPV) of an investment?

  Present value of cash flows
• The internal rate of return (IRR) is the discount rate that makes the NPV equal to zero.


  True
• Investment appraisal helps optimize resource allocation by ensuring funds are invested in projects with the highest return
• Investment appraisal ensures sustainable growth by evaluating potential projects and their alignment with business objectives.


  True
• The payback period is calculated by dividing the initial investment by the annual cash inflows
• What is the formula for calculating the accounting rate of return (ARR)?

  (Average Annual Profit / Initial Investment) * 100
• What is the internal rate of return (IRR) used for?

  Determining project feasibility
• Investment appraisal methods can help businesses improve profitability by choosing projects that enhance financial performance.


  True
• Match the investment appraisal method with its formula:

  Payback period ↔️ Initial Investment / Annual Cash Inflows

  Accounting rate of return (ARR) ↔️ (Average Annual Profit / Initial Investment) * 100

  Net present value (NPV) ↔️ Σ (Cash Flow / (1 + Discount Rate)^n) - Initial Investment

  Internal rate of return (IRR) ↔️ Iterative calculation
• The accounting rate of return (ARR) method considers the time value of money.

  False
• The net present value (NPV) method is sensitive to changes in the discount rate.
• What is the internal rate of return (IRR) used to determine?

  Project feasibility
• What is the payback period technique used to determine?

  Time to recover investment
• The accounting rate of return (ARR) calculates the average annual profit as a percentage of the initial investment
• What is one benefit of using investment appraisal methods?

  Improved profitability
• The net present value (NPV) formula considers the time value of money by discounting future cash flows.


  True
• The net present value (NPV) is calculated by discounting future cash flows at an appropriate rate
• Which investment appraisal method focuses solely on the time to recover the initial investment?

  Payback period
• The comparison of investment appraisal techniques should highlight both quantitative and qualitative
• What is one disadvantage of using the payback period method?

  Ignores cash flows after payback
• Net present value (NPV) considers the time value of money.


  True
• What discount rate makes the NPV of a project equal to zero?

  Internal rate of return
• Match the investment appraisal technique with its strength:

  Payback Period ↔️ Simple to calculate

  Accounting Rate of Return ↔️ Uses accounting profits

  Net Present Value ↔️ Considers time value of money

  Internal Rate of Return ↔️ Provides a percentage return figure
• What is the primary goal of capital investment appraisal?

  Evaluate project profitability
• Quantitative techniques should be balanced with qualitative factors such as strategic alignment and risk
• The accounting rate of return does not account for the time value of money.


  True
• The payback period measures the time it takes to recover the initial investment
• Investment appraisal can help optimize resource allocation.


  True
• Why is optimizing resource allocation a key benefit of investment appraisal?

  Highest return projects
• Investment appraisal helps mitigate potential financial risk
• What does strategic alignment ensure in investment appraisal?

  Long-term business goals
• Order the investment appraisal techniques from simplest to most complex:

  1️⃣ Payback Period

  2️⃣ Accounting Rate of Return

  3️⃣ Net Present Value

  4️⃣ Internal Rate of Return