Investment appraisal (A level BS)

From WikiTextbook

A bouncy castle company want to buy a new bouncy castle they need to consider about the investment.

Factors to consider when buying a bouncy castle:

    - Price/cost;
    - Reliability of the product;
    - Size – Capacity;
    - Novelty;
    - Brand Unique;
    - Depreciation;
    - Age;
    - Theme – Designs;
    - Overhead Costs;
    - Reputation;
    - Residual Value;
    - Income that can be generated;
    - How long will it take to pay for itself;

Three Key Financial Techniques

1. Payback

This method calculates the number of years it takes to recover the cost of an investment.

Advantages

o Easy to calculate; o Takes into account the timings of cash flow; o Focuses on the short-term – achieving the fastest return;

Disadvantage

o Ignores the level of profits generated; o Ignores what happens after the payback period;

Other factors to consider…

    - Staff morale
    - Reason for declining sales
    - Do the target market have access to the internet (over 60’s for example)
    - Objectives of the business.

2. Average Rate of Return (ARR)

This technique calculates the percentage rate of return on the investment. It is useful if we are comparing various investment options available to use.

Formula to calculate ARR

Average Profit per year/Assets initial cost x 100

Advantages

    - Can be compared to the returns from a bank or building society;
    - Focuses upon profitability;

Disadvantages

    - Ignores the value of the money invested;
    - Ignores the time taken to cover the cost of the investment;

3. Net Current Value

Money received in the business’s future is worth less to a firm than if the money were to be received today.

So, one of the main advantages of Discounted Cash Flow is that it takes into account the affect of time and interest rates on the value of money.

“What will the money we receive in the future by worth in today’s terms?”

When we convert the value of future revenue streams into their current work this is known as their PRESENT VALUE.

We can work out PRESENT VALUES by “discounting”.

Discounting is the process of adjusting the value of money received at some future date to its present value.

It is simply the reverse of adding interest.

You will be provided with discounting factors to help you work out the present value in the exam.

Links

Contributors