3.7.8

Question 1

Investment appraisal may be used to aid businesses in making decisions when investing in:

Answer 1

• non-current assets
• launching new products
• new technology
• expansion
• infrastructure.

Question 2

what is payback

Answer 2

calculates the length of time it takes for an investment to recoup its original cost

Question 3

what is average rate of return

Answer 3

calculates the annual average return over the life of an investment in order to compare the investment with other alternatives

Question 4

payback focuses on

Answer 4

the time taken to recoup the initial investment and considers the cash inflows over a number of years.

Question 5

payback is useful when

Answer 5

It is useful for firms who need a quick return and may be facing liquidity problems.

Question 6

if payback point falls between two years use formula

Answer 6

Amount remaining to recover/
Amount recovered in following year

Question 7

why is ARR useful

Answer 7

it measures the profit achieved on an investment over time, which can then be compared to other investments or the zero risk strategy of leaving money in a bank account.

Question 8

however what might happen to profits

Answer 8

may fluctuate considerably over the life of a project and this is not taken into account.

Question 9

ARR formula

Answer 9

average annual profit/assets initial cost

Question 10

3 steps to calculate ARR

Answer 10

1. Total income from investment - cost of investment = total profit from investment
2. Total profit from investment/ expected lifespan of asset =
   average annual profit
3. Average annual profit cost of investment × 100% = ARR

Question 11

financial investment criteria

Answer 11

• the rate of interest - using current rate of interest as a benchmark to judge investments against
• ROCE - is there an expected minimum % return on the investment?
• cost - can the firm finance the investment?

Question 12

non-financial investment criteria

Answer 12

• corporate objectives - does the investment support business strategy?
• ethics - does the investment support CSR policy?
• industrial relations - what will be the impact on employees?

Question 13

what is risk

Answer 13

Risk is the chance of an adverse outcome and the impact it might have.

Question 14

what might determine the level of risk associated with a particular investment

Answer 14

1. timescale of the investment
2. knowledge / expertise of the business in the investment
3. if the investment is in a new market
4. stability of the external environment (legal, political, social, etc.).

Question 15

A business can reduce the impact of any negative outcome by

Answer 15

agreeing prices in advance, providing allowances for revenue and costs, ensuring the firm has sufficient financial assets and developing contingency plans.

Question 16

what is sensitivity analysis

Answer 16

involves using variations in forecasting to allow for a range of outcomes.

Question 17

what does sensitivity analysis allow

Answer 17

a business to ask’what if’ questions and put in place plans to deal with these scenarios.

Question 18

why is sensitivity analysis useful

Answer 18

for identifying the possible risks involved in an investment if only a few variables are considered. The value of it depends on the accuracy of the data on which it is based.