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Description
Flashcards by Hollie Ferris, updated more than 1 year ago
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Created by Hollie Ferris
over 7 years ago
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| Question | Answer |
| What is payback? | It is the time taken for an investment to generate sufficient returns to pay back its initial costs |
| How do you calculate Payback? | The method involves subtracting the returns gained from the investment from the initial investment cost until there is nothing left to pay. |
| Advantages of Payback | - Easy to calculate and understand - Good for projects which tend to become obsolete fairly quickly; e.g. tech |
| Disadvantages of Payback | - Ignores cash flow after payback; after the payback period a project might have a higher payback each year but this wouldn't be taking into account thus effecting the decision made. - Ignores the time value of money |
| What is Average Rate of Return; ARR | It is the comparison of the total return/profit of an investment compared to it initial cost to see if the investment produces a good return. |
| How do you calculate ARR? | Average annual profit of the investment/Cost of the investment X100 |
| What is Net present value? | It is the net return of the investment when all revenues and costs have been converted into their current worth. The total value of the investment bringing it back to relevant time periods. |
| How do you calculate NPV? | By dividing the individual years cash inflow by the corresponding years discounting factor. |
| ARR Advantages | - Takes into account the full returns of a project over the life of the investment - Compares the returns to the initial cost showing the return on investment - Shows the profitability of the project - Opportunity cost of investment can clearly be seen |
| ARR Disadvantages | - Calculate the average annual profits therefore projects may be chosen even though the return takes a longer time. which might be problematic - Attaches no importance to the timing of the inflows of cash - Project may not be profitable for many years - Doesn't take into consideration inflation. |
| NPV Advantages | - This method takes into account the impact of inflation on the value of money over a period of time - Makes the opportunity cost of different projects very clear - Considers the returns and costs over the whole life of the project - Considers the timing of inflows by giving smaller discounts for inflow in earlier years. |
| NPV Disadvantages | - Deciding on an appropriate discounting factor id complex - Predicting the likely future which makes the inflation level hard to anticipate. |
| What are some other factors in investment decisions | - The level of risk involved in the investment - Actions of Rivals - Quality of data and forecasts made - The objectives of a business - the current financial position of the firm and availability of finance needed - The level of interest on any borrowing - The impact on the corporate image |
| What is sensitivity analysis? | It is the management technique that uses variations in forecast data to investigate a range of possible outcomes. |
| What does sensitivity analysis allow a business to do? | Allows a manager to alter variables in the data used in techniques such as investment appraisal. This will help identify the likelihood that different outcomes will be achieved and the level of risk involved. |
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