3.5 Investment Appraisal

• What is investment appraisal used to evaluate?

  Financial viability of projects
• Investment appraisal considers the time value of money.
• The payback period method calculates how long it takes to recover the initial investment
• Match the investment appraisal method with its description:

  Payback Period ↔️ Calculates time to recover initial investment

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

  Return on Investment (ROI) ↔️ Measures profitability of an investment
• What is the payback period for a project with an initial investment of $100,000$ and annual net cash inflows of $30,000$?


  3.33 years
• The Net Present Value (NPV) method ignores the time value of money.

  False
• The payback period is simple to understand but ignores cash flows after the payback period
• What is the primary advantage of the Net Present Value (NPV) method?

  Considers time value of money
• Match the investment appraisal method with its main advantage:

  Payback Period ↔️ Simple to understand

  Net Present Value (NPV) ↔️ Considers time value of money

  Return on Investment (ROI) ↔️ Easy to calculate
• The payback period method considers the profitability of a project over its entire lifespan.

  False
• The payback period formula is the initial investment divided by the annual net cash inflow
• Investment appraisal is a process used to evaluate the financial viability of potential investment projects
• The purpose of investment appraisal is to determine if a proposed project will generate sufficient financial returns to justify the investment.
• Match the key benefits of investment appraisal with their descriptions:

  Informed Decision-Making ↔️ Provides data-driven insights

  Risk Management ↔️ Helps identify potential financial risks

  Resource Allocation ↔️ Ensures resources go to profitable projects

  Strategic Alignment ↔️ Aligns decisions with business strategy
• The payback period calculates how long it takes to recover the initial investment
• The net present value (NPV) method considers the time value of money.
• The return on investment (ROI) measures the profitability of an investment.
• What is the payback period if the initial investment is $100,000$ and the annual net cash inflow is $30,000$?


  3.33 years
• The payback period ignores cash flows after the payback period
• Why is the NPV method considered superior to the payback period method?

  Considers time value of money
• The return on investment (ROI) method considers the time value of money.

  False
• Match the investment appraisal method with its formula:

  Payback Period ↔️ $\frac{Initial\ Investment}{Annual\ Net\ Cash\ Inflow}$

  Net Present Value (NPV) ↔️ $\sum_{t = 1}^{n} \frac{CF_{t}}{(1 + r)^{t}} - Initial\ Investment$

  Return on Investment (ROI) ↔️ $\frac{Net\ Profit}{Initial\ Investment} \times 100$
• The payback period is the time required to recover the initial investment
• The payback period considers the time value of money.

  False
• What is the payback period if the initial investment is $200,000$ and the annual net cash inflow is $50,000$?


  4 years
• The average rate of return (ARR) measures the profitability of an investment relative to its cost
• The ARR considers the time value of money.

  False
• What is the ARR if the initial investment is $500,000$ and the average annual profit is $100,000$?


  20%
• Match the common investment appraisal methods with their primary use:

  Payback Period ↔️ Assess liquidity and risk

  Net Present Value (NPV) ↔️ Determine project profitability

  Return on Investment (ROI) ↔️ Measure investment efficiency
• Investment appraisal ensures efficient resource allocation
• The NPV method requires estimation of future cash flows
• The return on investment (ROI) measures the profitability of an investment.
• The payback period is calculated by dividing the initial investment by the annual net cash inflow
• The payback period considers the time value of money.

  False
• The ARR formula multiplies the average annual profit by 100 and divides it by the initial investment
• The ARR can be skewed by large profits in later years.
• Match the investment appraisal method with its key feature:

  Payback Period ↔️ Simplicity in calculation

  Net Present Value (NPV) ↔️ Considers time value of money

  Average Rate of Return (ARR) ↔️ Measures profitability relative to cost
• What is the Average Rate of Return (ARR) formula?

  $ARR =$$\frac{Average\ Annual\ Profit}{Initial\ Investment} \times 100$
• The ARR for an initial investment of $500,000$ and average annual profit of 100,000</latex> is 20%
• The Net Present Value (NPV) considers the time value of money.