3.3.2 Investment Appraisal

• Investment appraisal is the process of evaluating the profitability and financial viability of potential investment projects
• Investment appraisal is important because it helps businesses make informed decisions about resource allocation
• Match the investment appraisal technique with its formula:

  Payback Period ↔️ $\frac{\text{Initial Investment}}{\text{Annual Cash Flow}}$

  Average Rate of Return ↔️ $\frac{\text{Average Annual Profit}}{\text{Initial Investment}} \times 100\%$

  Net Present Value ↔️ $\sum_{t = 0}^{n} \frac{\text{Cash Flow}}{(1 + r)^{t}} - \text{Initial Investment}$
• The payback period measures how long it takes to recover the initial investment
• The average rate of return considers the time value of money.

  False
• Businesses must evaluate the advantages and disadvantages of each investment appraisal technique
• Qualitative factors such as environmental impact or employee morale should be considered in investment appraisal
• Comparing investment appraisal techniques helps businesses choose the most suitable method for their needs.
• The payback period is a simple method that ignores the time value of money
• Investment appraisal evaluates the profitability and financial viability
• The average rate of return calculates the percentage return based on the average annual profit
• The net present value method accounts for the time value of money
• Order the steps in calculating the net present value:

  1️⃣ Determine the discount rate

  2️⃣ Calculate the present value of each cash flow

  3️⃣ Sum the present values of all cash flows

  4️⃣ Subtract the initial investment
• Match the investment appraisal method with its key advantage:

  Payback Period ↔️ Simple and fast

  ARR ↔️ Considers profitability

  NPV ↔️ Comprehensive and accounts for time value of money
• Risk mitigation is a key benefit of investment appraisal
• Investment appraisal ensures resources are invested in the least profitable opportunities.

  False
• Investment appraisal informs strategic plans and helps set long-term business goals
• Investment appraisal can help compare two projects with equal initial investments to determine which provides a better return.
• Common investment appraisal techniques include payback period, average rate of return, and net present value
• What does the Payback Period determine?

  Time to recover investment
• The Average Rate of Return (ARR) calculates the percentage return based on average profit
• What does the Net Present Value (NPV) calculate?

  Present value of cash flows
• The Payback Period is a simple and fast method for measuring liquidity.
• What is the formula for ARR?

  \frac{\text{Average Annual Profit}}{\text{Initial Investment}} \times100\%</latex>
• The Net Present Value (NPV) considers the time value of money
• What is the primary disadvantage of the Payback Period?

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

  Payback Period ↔️ Measures liquidity

  ARR ↔️ Considers profitability

  NPV ↔️ Considers time value of money
• What is the payback period if the initial investment is $100,000$ and the annual cash flow is $25,000$?


  4 years
• Investment appraisal evaluates the profitability and financial viability of projects.
• What is the NPV of a project with an initial investment of $500,000$, annual cash flow of $150,000$, and a discount rate of 5%?


  $147,340$
• Investment appraisal informs strategic plans and sets long-term goals
• Why is investment appraisal crucial for businesses?

  Risk mitigation
• Investment appraisal ensures resources are invested in the most profitable opportunities
• Investment appraisal enhances profitability by prioritizing projects with the highest returns.
• What role does investment appraisal play in strategic decision-making?

  Informs strategic plans
• Investment appraisal can determine the better project based on estimated cash flows and payback periods.
• What does the payback period technique measure?

  Time to recover investment
• The formula for the payback period is: \frac{\text{Initial Investment}}{\text{Annual Cash Flow}}
• The payback period is advantageous because it is simple and measures liquidity.
• What does the average rate of return (ARR) calculate?

  Percentage return based on profit