What is investment appraisal?

Investment appraisal is the set of techniques a business uses to judge whether a capital project is worth undertaking. Each technique compares the money laid out with the returns expected.

What is the purpose of investment appraisal?

Investment appraisal establishes whether a project meets the return the business requires, and which of several projects is best. Capital is limited, so the choice has to be justified.

What is the payback period?

The payback period is the time taken for net cash inflows to equal the initial outlay. A business uses the measure to judge how quickly its money comes back. The result is normally expressed in years and months.

Give two advantages of the payback method.

Payback is simple to calculate and easy for non-financial managers to understand. Favouring quick returns also suits a business whose main concern is liquidity.

Eduqas A-Level Business A510QS

Enterprise, Business Plans and Location

Topic overview Enterprise, entrepreneurs and SMEs Needs, wants and spotting a business opportunity The role of the entrepreneur in setting up and running a business Financial and non-financial motives of entrepreneurs Characteristics and skills of entrepreneurs Entrepreneurs, SMEs and the sectors of the UK economy Stakeholders and their interests Business plans and sources of advice Choosing a business location

Markets, Demand and Market Research

Topic overview Markets and competition Types of market Market size, market share and market trends Market segmentation Market structures and degrees of competition Consumer protection Demand and the factors that shift it Supply and the factors that shift it Equilibrium price and shifts in the market Price and income elasticity of demand Primary and secondary market research Qualitative and quantitative data Sampling and bias in market research

Business Structure and Sources of Finance

Topic overview The private sector and the public sector Aims of private sector businesses Sole traders and partnerships Private and public limited companies Unlimited and limited liability Choosing a legal structure Not-for-profit organisations Internal and personal sources of start-up finance Borrowing, equity and grants for a small business

Revenue, Costs and Break-Even

Topic overview Revenue, costs and profit Fixed, variable and semi-variable costs Direct costs, indirect costs and overheads Calculating revenue, costs and profit Contribution and its uses Calculating the break-even point Break-even charts and the margin of safety What-if analysis of changes in costs and revenue The usefulness and limits of break-even

Marketing and the Marketing Mix

Topic overview The purpose of marketing and market orientation The marketing mix and the four Ps Product, brand, USP and differentiation The product life cycle Extension strategies The product life cycle and cash flow The Boston matrix Pricing strategies Choosing the right pricing strategy Promotion above the line and below the line Place and distribution channels The marketing mix in different contexts New technology in marketing

Financial Planning and Accounts

Topic overview The role of the finance department Budgets and the purpose of budgeting The benefits and drawbacks of budgets Internal sources of finance External sources of finance Choosing the right source of finance Cash flow and cash flow forecasts Constructing and interpreting a cash flow forecast Cash flow problems and how to improve cash flow The income statement, gross profit and net profit Gross and net profit margins

People in Organisations

Topic overview The role of the human resource department The flexible workforce New technology and changing working patterns Workforce planning The recruitment process, job analysis and job descriptions Internal and external recruitment Methods of selecting employees Methods of training The value of training to a business Appraisal and its methods Measuring workforce performance Organisational structures and the chain of command Delegation, empowerment and delayering

Motivation, Management and Employee Relations

Topic overview Motivation and the benefits of a motivated workforce Taylor and scientific management Mayo and the Hawthorne studies Maslow's hierarchy of needs Herzberg's two factor theory Expectancy theories of Vroom, Porter and Lawler Financial methods of motivation Non-financial methods of motivation Management, management by objectives and Theory X and Y Leadership and leadership styles Leadership theories and choosing a style Employment rights, contracts and equal opportunities Trade unions, industrial conflict and dispute resolution

Operations Management

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Data and Market Analysis

Topic overview Presenting and interpreting business data Index numbers and comparing figures over time Calculating price elasticity of demand Interpreting price elasticity and its effect on revenue Income elasticity of demand Sales forecasting and the reliability of a forecast Moving averages and time-series analysis Correlation, scatter graphs and extrapolation Qualitative forecasting techniques

Analysing Business Performance

Topic overview Budget variances and how to calculate them Analysing and evaluating budget variances The balance sheet and how it is constructed Working capital, capital employed and depreciation Liquidity ratios: the current ratio and the acid test Return on capital employed and gearing Comparing accounts over time and between businesses Evaluating the financial position of a business Non-financial measures of performance and vision statements

Aims, Objectives and Strategy

Topic overview Aims, objectives and SMART targets Mission and vision statements Strategy, tactics and corporate plans SWOT analysis Porter's Five Forces The Ansoff matrix Organic growth External growth: mergers and takeovers Horizontal and vertical integration Franchising as a method of growth Rationalisation and relocation Outsourcing production

Decision-Making and Investment Appraisal

Topic overview Types of business decision Scientific and intuitive decision-making Decision trees: constructing and calculating Evaluating decision tree analysis Critical path analysis: building the network Interpreting and evaluating critical path analysis Cost benefit analysis Payback and the average rate of return Discounted cash flow and net present value Choosing between investments Special orders

Change and Risk Management

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PEST Factors and the External Environment

Topic overview Political factors and the role of government Taxation and subsidies Fiscal and monetary policy Economic growth, GDP and the business cycle Inflation and how it is measured Interest rates and exchange rates Unemployment Demographic change Social and cultural change Technological factors and automation

Ethical, Legal and Environmental Factors

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International Trade, Globalisation and the European Union

Topic overview International trade and why it happens Free trade and protectionism Trading blocs and the single market Entering new international markets Globalisation and its causes The effects of globalisation on business Strategies for global growth Glocalisation and adapting to local markets Multinational companies The European Union and the single European market The euro, the Eurozone and membership

Decision-Making and Investment Appraisal

Payback and the average rate of return

3 things to know
Component 2

Overview

Investment appraisal, payback period and average rate of return.

What you need to know

Answer each one before you reveal it.

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Numbers

A machine costs £100,000 and returns £30,000 in year one, £40,000 in year two and £60,000 in year three. Calculate the payback period.

Numbers

A vehicle costs £48,000 and returns £16,000 each year. Calculate the payback period.

Evaluation

Give two disadvantages of the average rate of return.

Questions from this subtopic

Each one with the model answer underneath.

1
What is investment appraisal?
Model answer
Investment appraisal is the set of techniques a business uses to judge whether a capital project is worth undertaking. Each technique compares the money laid out with the returns expected.
2
What is the purpose of investment appraisal?
Model answer
Investment appraisal establishes whether a project meets the return the business requires, and which of several projects is best. Capital is limited, so the choice has to be justified.
3
What is the payback period?
Model answer
The payback period is the time taken for net cash inflows to equal the initial outlay. A business uses the measure to judge how quickly its money comes back. The result is normally expressed in years and months.
4
A machine costs £100,000 and returns £30,000 in year one, £40,000 in year two and £60,000 in year three. Calculate the payback period.
Model answer
Cumulative inflows reach £70,000 by the end of year two, leaving £30,000 outstanding. Year three brings £60,000, so £30,000 divided by £60,000 multiplied by 12 gives 6 months. The payback period is 2 years and 6 months.
5
A vehicle costs £48,000 and returns £16,000 each year. Calculate the payback period.
Model answer
Payback equals the initial outlay divided by the annual inflow where inflows are constant. The outlay here is £48,000 and the annual inflow £16,000. The payback period is therefore 3 years.
6
Give two advantages of the payback method.
Model answer
Payback is simple to calculate and easy for non-financial managers to understand. Favouring quick returns also suits a business whose main concern is liquidity.

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