Investment appraisal: quantitative and qualitative evaluation of an investment desicion

Working capital: the money available to meet your current short term liabilities

There are three methods:

- Payback period: used to work out the number of years and months it will take for the investment
of a business to pay for itself
- Average rate of return: technique that expresses the annual forecast as a percentage of the initial
capital cost
- Net present value: shows the real value of estimated future net cash flows so that the investment
appraisal is more accurate

Net present value

Pros:

- considers the change in value of money over time, which provides the business with a more.
accurate understanding of the future value of cash flows for an investment.
- Considers inflation.
- Can handle multiple discount rates or varying cash flows.
- Takes into account time value of money
- Takes into account all future cash flows

Cons:

- Challenging to accurately arrive at a discount rate that represents the investment’s true risk.
- Complicated to calculate in comparison to ARR and payback period.
- Assumptions of the future value of money have to made and this can be inaccurate.
- Discount rate chosen to calculate present value could be inaccurate depending on future economic
conditions.
- Don’t know if the discount rate chosen is the appropriate on to use.

The higher the discount rate the smaller the present value

Project that gives highest net present value, that is the one that you pick/ go for

Present value (single year) = Net cash flow x discount factor

Net present value (NVP) = Sum of all present values of return – original cost