Investment appraisal
Payback is the shortest time it will take to recoup the investment.
1. Work out full years (amount of time it will take).
2. If the investment will be fully paid in the middle of the year, use this equation:
3. Amount left to pay back / revenue expected in the following year
4. Then multiply the number by 12, this will give you the number of months.
5. Then add this number to full years in step 1.
Advantages of using payback period:
Simple to use.
Easy to calculate.
Effective to use when technology is changing at a fast rate.
Helps with managing cashflow.
Disadvantages of using payback period:
Ignores flows of cash over the lifetime of the project.
Ignores total profitability, the focus is just on the speed to which the initial outlay is repaid.
Average rate of return in the largest percentages return (ARR).
1. Add up all the revenue the investment will generate (expected revenue).
2. Minus any operating costs if there are any.
3. Minus the initial costs of the investment/project.
4. Divide by the number of years the investment/project will last to.
5. Divide again by the initial investment cost and multiply by 100 to get the percentage.
Advantages of using ARR:
Shows profitability of the option/project.
Includes all the projects cashflows.
Easy to compare different projects.
Disadvantages of using ARR:
Ignores timing of cashflow.
Does not account for inflation.
Net present value – the business wants the largest positive value/number.
1. Multiply the expected revenue by the appropriate discount factor – each year.
2. Add up all the present values you just calculated and get the total.
3. Subtract the initial cost of the investment.
4. Divide the answer by number of years to get NPV per year.
5. Divide by the cost (investment), then * by 100 to get NPV as a percentage (%).
Advantages of using NPV:
Payback is the shortest time it will take to recoup the investment.
1. Work out full years (amount of time it will take).
2. If the investment will be fully paid in the middle of the year, use this equation:
3. Amount left to pay back / revenue expected in the following year
4. Then multiply the number by 12, this will give you the number of months.
5. Then add this number to full years in step 1.
Advantages of using payback period:
Simple to use.
Easy to calculate.
Effective to use when technology is changing at a fast rate.
Helps with managing cashflow.
Disadvantages of using payback period:
Ignores flows of cash over the lifetime of the project.
Ignores total profitability, the focus is just on the speed to which the initial outlay is repaid.
Average rate of return in the largest percentages return (ARR).
1. Add up all the revenue the investment will generate (expected revenue).
2. Minus any operating costs if there are any.
3. Minus the initial costs of the investment/project.
4. Divide by the number of years the investment/project will last to.
5. Divide again by the initial investment cost and multiply by 100 to get the percentage.
Advantages of using ARR:
Shows profitability of the option/project.
Includes all the projects cashflows.
Easy to compare different projects.
Disadvantages of using ARR:
Ignores timing of cashflow.
Does not account for inflation.
Net present value – the business wants the largest positive value/number.
1. Multiply the expected revenue by the appropriate discount factor – each year.
2. Add up all the present values you just calculated and get the total.
3. Subtract the initial cost of the investment.
4. Divide the answer by number of years to get NPV per year.
5. Divide by the cost (investment), then * by 100 to get NPV as a percentage (%).
Advantages of using NPV:
