Some investment decisions may have a longer-term impact and therefore longer-term appraisal techniques will need to be used. These techniques were studied in earlier papers (F5 and F9).
- NPV
- IRR
- ARR
- Payback Period
Some investment decisions may have a longer-term impact and therefore longer-term appraisal techniques will need to be used. These techniques were studied in earlier papers (F5 and F9) and the key points to remember are as follows:
Method: | Net Present Value (NPV) |
How to calculate | Use a cost of capital and discount factors to discount future cash flows to give the present value |
Best used when | The project is long and the cost of capital is known |
Key advantage | Gives an absolute estimate of the impact on shareholder wealth |
Key disadvantage | Relies on a reliable cost of capital estimate |
Method: | Payback period |
How to calculate | Determine how quickly the original cash injection is recovered |
Best used when | The project is short and/or cash is in short supply |
Key advantage | Provides a minimum target for project life |
Key disadvantage | Requires a target/benchmark |
Method: | Accounting Rate of Return (ARR) |
How to calculate | Divide average profits by the initial investment |
Best used when | The project has profit targets to meet |
Key advantage | A simple calculation based on readily available information |
Key disadvantage | Profits are easily manipulated |
Method: | Internal Rate of Return (IRR) |
How to calculate | Determine the cost of capital that provides a zero NPV |
Best used when | The project is long and the cost of capital has not yet been determined |
Key advantage | A simple calculation based on readily available information |
Key disadvantage | Profits are easily manipulated |
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