3.3

Question 1

definition of investment appraisal

Answer 1

process of analyzing whether investment projects are worthwhile

Question 2

three main methods of investment appraisal

Answer 2

• payback period (time)
• average rate of return %
• discount cash flow (NPV) £

Question 3

payback period

Answer 3

time it takes for a project to repay its initial investment.

Question 4

benefits of using a payback period

Answer 4

• simple to calcultate
• focus on cash flows
• emphasizes speed of returns
• comparable

Question 5

drawbacks of using a payback period

Answer 5

• ignore cash flows after payback has been reached
• net cash flows are expected to be constant
• no account of the “time value of money”
• ignores qualitative aspects of the decision
• Short-term thinking

Question 6

what is ARR

Answer 6

annual % return on an investment project based on average returns earned by the project

Question 7

equation for ARR

Answer 7

total net cash - initial investments =A
A / initial investments x 100 = B
B / years = ARR

Question 8

benefits of using ARR

Answer 8

• simple to understand and calculate
• comparable with other target rates

Question 9

drawbacks of ARR

Answer 9

• ignore timings of result
• focuses on profits rather than cash flows
• not adjusted for time-value of money

Question 10

NPV

Answer 10

calculates the monetary value now of a projects future cash flow

Question 11

discounting definition

Answer 11

method used to reduce the future value of cash flows to reflect the risk that they may not happen

Question 12

what is the time-value of money

Answer 12

• better to receive cash now then in the future
• future cash flows are worth less

Question 13

NPV calculation

Answer 13

net cash flow x discount factor

Question 14

NPV analysis

Answer 14

NPV - initial investment

+ve = accept project
-ve = reject project

Question 15

benefits of NPV

Answer 15

• considers all future cash flows
• reflects risks
• different levels of risks can be accounted for by adjusting the discount rate
• straightforward decision

Question 16

drawbacks of NPV

Answer 16

• choosing the discount rate is hard - as you do not know what the future bank interest rate will be

Question 17

Limitations of investment appraisal

Answer 17

• Forecasted future cash flow may be inaccurate
• Corporate objectives aren’t considered
• potential for +ve pr are not considered
• business finances + availability of external finances to fund the investment

Question 18

what is network analysis

Answer 18

technique used to identify the order in which all activities need to be completed when planning a complex project

Question 19

how do network and critical path diagrams work

Answer 19

organise activities to show which activities can be done simultaneously and which are dependent on earlier activities

Question 20

what does a critical pathway identify

Answer 20

the shortest time in which a project can be completed

Question 21

network diagrams features:

Answer 21

• made up of 3 nodes
• EST earliest start time (top, right)
• LFT - latest activity can finish without delaying the project
• the node number based on the order in which it is drawn

Question 22

what does the LFT on the final node need to match

Answer 22

matches the EST on that node

Question 23

What happens when two or more activities of in the same node for LFT

Answer 23

choose the lower number

Question 24

critical path analysis advantages

Answer 24

• shorten overall tiem of proejct
• allows for just in time
• identifies critical activities
• improves focus on the projects

Question 25

critical path analysis disadvantages

Answer 25

- relies on estimations - doesn't take into account external influences - large projects can be to complex for CPA

Question 26

what is the total float

Answer 26

the amount of time an activity can be delay without affecting the end time of the entire project

Question 27

total float formula

Answer 27

LFT this activity - duration - EST this activity

Question 28

what is free float

Answer 28

amount of time that a task can be delayed without delaying the following task

Question 29

free float formula

Answer 29

EST next - duration - EST this

Question 30

what does a negative NPV mean

Answer 30

the firm could get a better return by putting their money in a savings account, than going ahead with the project

Question 31

a positive of critical path analysis

Answer 31

firms can forecast their cash flow, as definitive start times allow the firm to budget accurately, and know what activities need cash

Question 32

two approaches to sales forecasting

Answer 32

- extrapolation - correlation

Question 33

extrapolation definition

Answer 33

uses trends established from historical data to forecast the future

Question 34

moving averages used in extrapolation

Answer 34

- moving average takes a data series and "smooths" the fluctuations in data to show an average - the aim is to take out extreme data

Question 35

factors to consider with moving averages

Answer 35

- product life cycle - pace of technological innovation - growth of the global economy - market saturation

Question 36

extrapolation advantages

Answer 36

- simple method of forecasting - mot much data required - quick and cheap

Question 37

extrapolation disadvantages

Answer 37

- unreliable due to fluctuations in historical data - assumes past trends will continue - ignores qualitative factors

Question 38

correlation definition

Answer 38

looks at the strength of a relationship between two variables

Question 39

correlation variables

Answer 39

- indpendant variables - change - dependant variables - measure

Question 40

what is the regression line

Answer 40

plots the mathematical relationship between the variables based on the data points

Question 41

how to work out if you have a strong correlation

Answer 41

there is little room between the data points and the line of best fit

Question 42

how to work out if you have a weak correlation

Answer 42

the data points are spread quite wide and far away from the line of best fit

Question 43

factors affecting sale forecasts

Answer 43

- consumer trends - economic variables - competitor actions

Question 44

circumstances where sales forecasts are likely to be inaccurate

Answer 44

- start-up business - disruption of technological change - changes in market share - management that have demonstrated poor forecasts in the past

Question 45

what is a decision tree

Answer 45

- A mathematical model - Used to help managers make decisions - Uses estimates and probabilities to calculate likely outcomes - decides whether the net gain from a decision is worthwhile

Question 46

what does the expected value mean in a decision tree

Answer 46

The financial value of an outcome calculated by multiplying the estimated financial effect by its probability

Question 47

what does the net gain mean in a decision tree

Answer 47

value to be gained from taking a decision. Calculated by adding together the expected value of each outcome and deducting the costs associated with the decision

Question 48

advantages of decision trees

Answer 48

- Choices are set out in a logical way - Potential options & choices are considered at the same time - costs are considered as well as benefits - Easy to understand & tangible results

Question 49

disadvantages of decision trees

Answer 49

- Probabilities are just estimates - Uses quantitative data only - Assignment of probabilities and expected values prone to bias - Decision-making technique doesn’t necessarily reduce the amount of risk