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Edexcel A-Level Accounting
2. Corporate and Management Accounting
2.3 Investment Appraisal
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What is the main purpose of investment appraisal?
Evaluate profitability and feasibility
The Payback Period method determines how long it takes for an investment to pay back its initial
cost
Net Present Value (
NPV
) calculates the difference between the present value of cash inflows and outflows.
What does the Internal Rate of Return (IRR) find?
Discount rate where NPV is zero
The IRR formula calculates the discount rate that makes the NPV equal to
zero
Match the investment appraisal method with its description:
Payback Period ↔️ Time to recover initial cost
Net Present Value ↔️ Present value of cash flows
Internal Rate of Return ↔️ Discount rate where NPV is zero
Steps to calculate Payback Period
1️⃣ Determine the initial investment
2️⃣ Calculate the annual cash inflows
3️⃣ Divide the initial investment by the annual cash inflow
An example with an initial investment of $50,000 and annual cash inflow of $10,000 results in a Payback Period of
5
What does NPV stand for in investment appraisal?
Net Present Value
Internal Rate of Return (IRR) is the discount rate at which NPV equals
zero
Payback Period considers all cash flows over the investment's lifespan.
False
What formula is used to calculate NPV?
NPV = \sum_{t = 0}^{n} \frac{CF_{t}}{(1 + r)^{t}}</latex>
IRR provides a discount rate as a
percentage return
.
Payback Period is calculated by dividing the initial investment by the annual cash
inflow
Steps to calculate Payback Period
1️⃣ Determine the initial investment
2️⃣ Calculate the annual cash inflows
3️⃣ Divide the initial investment by the annual cash inflow
What is the Payback Period for an initial investment of $50,000 and annual cash inflow of $10,000?
5 years
What does Accounting Rate of Return (ARR) measure?
Average annual profit as a percentage
What is the ARR for a total profit of $150,000, investment lifespan of 5 years, and initial investment of $200,000?
15%
NPV calculates the difference between the
present value
of cash inflows and outflows.
What formula is used to calculate the present value of a single cash flow?
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A negative
NPV
indicates that the project is not recommended.
What is the primary purpose of investment appraisal?
Evaluate project profitability
Match the investment appraisal method with its description:
Payback Period ↔️ Time to recover initial cost
NPV ↔️ Difference between present values
IRR ↔️ Discount rate where NPV is zero
Steps to calculate Net Present Value (NPV)
1️⃣ Determine the cash flows for each period
2️⃣ Calculate the present value of each cash flow
3️⃣ Sum all present values to get the total present value
4️⃣ Subtract the initial investment from the total present value
What is the Payback Period for an initial investment of $50,000 and annual cash inflow of $10,000?
5 years
Accounting Rate of Return (ARR) measures the average annual profit as a percentage of the initial
investment
What is the formula for ARR?
A
R
R
=
ARR =
A
RR
=
Average Annual Profit
Initial Investment
×
100
\frac{\text{Average Annual Profit}}{\text{Initial Investment}} \times 100
Initial Investment
Average Annual Profit
×
100
What is the ARR for a total profit of $150,000, investment lifespan of 5 years, and initial investment of $200,000?
15%
NPV helps determine if an investment is profitable by comparing inflows and
outflows
.
What formula is used to calculate the present value of a single cash flow in NPV?
PV = \frac{CF}{(1 + r)^{t}}</latex>
A negative NPV indicates that the project should be accepted.
False
What does investment appraisal help determine?
Project profitability
The formula for calculating present value (PV) is
PV
To find the Net Present Value (NPV), you subtract the initial investment from the
total present value
.
What is the initial investment in the example provided?
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If the Net Present Value (NPV) is negative, the project is recommended.
False
What does the Internal Rate of Return (IRR) indicate?
Breakeven profitability
In the example provided, the Internal Rate of Return (IRR) is approximately
12.99%
What is a primary disadvantage of the Payback Period method?
Ignores time value of money
A positive Net Present Value (
NPV
) indicates a profitable investment.
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