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Topic 3: Accounts and finance

Topic 3: Accounts and finance. 3.2 Investment Appraisal. LO1: Calculate the payback period and ARR for an investment. LO2: Analyse the results of the calculations. Investment Appraisal. Business is stable. Cash flow under control. Making a profit. How to expand?

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Topic 3: Accounts and finance

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  1. Topic 3: Accounts and finance

  2. 3.2 Investment Appraisal • LO1: Calculate the payback period and ARR for an investment. • LO2: Analyse the results of the calculations.

  3. Investment Appraisal • Business is stable. • Cash flow under control. • Making a profit. • How to expand? • Quantitative vs. Qualitative

  4. Payback Period • Measure time taken to recovery initial investment. • New machine: $100,000 • Generate extra $25,000 per year. • What is the Payback Period?

  5. Payback Period • Results are compared with other options • Decisions are influenced by this. • What are other option for this company?

  6. Payback Period • Quick and easy • Results are simple • Accurate on short term • Results allow business to stay focussed • Important to businesses where liquidity is more important than profitability

  7. Payback Period • Doesn’t measure overall profitability • Focus on short term may reject great long term projects • Doesn’t consider timing of cash flows

  8. Average Rate of Return (ARR) • Another method of measuring success of investments. • Profitability of project over its life. • Benefit: Consider all data, not just cash flow up till payback. • First we need to calculate Average Return (AR) ...

  9. Average Return (AR)

  10. Average Rate of Return (ARR) • Once AR is know, you can work out ARR. • Annualized Net Profit ÷ • initial Investment x 100 = • Average rate of Return as a percentage (%) • S&S Textbook, Exercises pages 189 and 193/194

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