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    An Introduction To Investment Appraisal: The Initial Outlay For That Investment

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    almasmalik296
    An introduction to investment appraisal involves comparing expected future cash flows to initial outlay. Key data like sales forecasts, costs and borrowing costs must be collected before appraising investments using methods like simple payback period, average rate of return, and net present value. The simple payback period calculates the time for an investment's cash flows to recoup its cost. It is a simple method but does not consider timing or value of future cash flows.

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    An Introduction To Investment Appraisal: The Initial Outlay For That Investment

    Uploaded by

    almasmalik296
    41 views4 pages
    An introduction to investment appraisal involves comparing expected future cash flows to initial outlay. Key data like sales forecasts, costs and borrowing costs must be collected before appraising investments using methods like simple payback period, average rate of return, and net present value. The simple payback period calculates the time for an investment's cash flows to recoup its cost. It is a simple method but does not consider timing or value of future cash flows.

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    An introduction to investment appraisal involves comparing expected future cash flows to initial outlay. Key data like sales forecasts, costs and borrowing costs must be collected before appraising investments using methods like simple payback period, average rate of return, and net present value. The simple payback period calculates the time for an investment's cash flows to recoup its cost. It is a simple method but does not consider timing or value of future cash flows.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    41 views4 pages

    An Introduction To Investment Appraisal: The Initial Outlay For That Investment

    Uploaded by

    almasmalik296
    An introduction to investment appraisal involves comparing expected future cash flows to initial outlay. Key data like sales forecasts, costs and borrowing costs must be collected before appraising investments using methods like simple payback period, average rate of return, and net present value. The simple payback period calculates the time for an investment's cash flows to recoup its cost. It is a simple method but does not consider timing or value of future cash flows.

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    An Introduction to Investment Appraisal

    • Investment appraisal involves comparing the expected future cash flows of an investment with
    the initial outlay for that investment

    • A business may want to analyse


    o How soon the investment will recoup the initial outlay
    o How profitable the investment will be

    • Before an investment can be appraised key data will need to be collected, including
    o Sales forecasts
    o Fixed and variable costs data
    o Pricing information
    o Borrowing costs

    • The collection and analysis of this data is likely to take some time
    o It requires significant experience to interpret the data appropriately before the
    investment appraisal can take place

    • Different methods are used to appraise the value of an investment, including:


    o The simple payback period
    o The average rate of return (ARR)
    o The net present value of discounted cash flow

    Simple Payback Period

    • The payback period is a calculation of the amount of time it is expected an investment will take
    to pay for itself
    • Where net cash flows are expected to be constant over time the payback period can be
    calculated using the formula

    Worked example
    1. Simple Payback Calculation
    Gomez Carpets is considering an investment in a new storage facility at a cost of
    £200,000. It expects additional net cash flow of £30,000 per year as a result of the
    investment.

    Calculate the Payback period for the investment. (3)

    Step 1 - Divide the initial outlay by the additional expected net cash flow

    (1 mark)

    Step 2 - Convert the outcome to years and months


    6 years

    0.67 years = 8.04 months (1 mark)

    Payback period = 6 years and 8 months (3 marks for the correct answer)

    Worked example
    2. Payback calculation for varying cash flow over time

    Hammer and Son provides a household repairs service that has recently employed a
    new handywoman who requires her own van. The new van will be purchased for
    £32,000

    The net cash flows are expected to vary over the five years following its purchase and
    are shown in the table below.

    Net cash Cumulative


    Year
    Flow (£) Cash Flow (£)

    0 (32,000) (32,000)

    1 14,000 (18,000)

    2 10,000 (8,000)

    3 6,000 (2,000)

    4 3,000 1,000

    5 2,000 3,000

    Calculate the payback period for the van (4)

    Step 1 - Identify the final year where the cumulative cash flow is negative

    In this case the cumulative cash flow figure is -£2,000 at the end of Year 3

    This is the remaining amount (outlay) outstanding. (1 mark)

    Step 2 - Calculate the monthly net cash flow for the next year
    £3,000 ÷ 12 (months) = £250 (1 mark)

    Step 3 - Divide the remaining outlay outstanding by the monthly net cash flow

    £2000 ÷ £250 = 8 months (1 mark)

    Step 4 - Identify the payback period

    In this case the Payback period is 3 years and 8 months (1 mark)

    Benefits and Drawbacks of the Using the Payback Method

    Benefits Drawbacks

    • It is a simple • It provides no
    method to insight into
    calculate and the profitability of
    understand investments

    • It is particularly • Payback only


    useful for considers the total
    businesses length of time
    where the cash to recover an
    flow investment
    management is
    vital
    • Neither the timing nor
    the future value of
    • Businesses cash inflows is
    can identify the considered
    point at which an
    investment is
    paid back • It may encourage
    and contributing a short-
    positively to termism approach
    cash flow

    • Potentially
    lucrative investments
    • It is also useful may be
    where new dismissed as they
    technology is take longer to pay
    introduced back than alternatives
    regularly

    • Businesses
    purchasing
    equipment can
    calculate
    whether an
    investment ‘pays
    back’ before an
    upgrade is
    available

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