State the purpose of investment appraisal.

It compares the cost of an investment with the returns it is forecast to generate, so that scarce funds go to the projects offering the best return for the risk.

Define the payback period.

The payback period is the length of time it takes for the net cash inflows from an investment to cover its initial cost.

A machine costs £240,000 and generates net cash inflows of £80,000, £100,000, £120,000 and £120,000 over four years. Calculate the payback period.

£180,000 is recovered by the end of year two and the remaining £60,000 takes half of year three, so payback is 2 years and 6 months.

A project costs £150,000 and generates inflows of £50,000, £50,000, £60,000, £60,000 and £60,000. Calculate the payback period.

£100,000 is recovered in two years and the remaining £50,000 takes ten months of year three, so payback is 2 years and 10 months.

WJEC A-Level Business 601-5238-2

Enterprise and Starting a Business

Topic overview Enterprise and the entrepreneur Stakeholders in a business Business plans and sources of support Legal structures of business The public and private sectors Business location Sources of finance for a new business Business revenue, costs and profit

Markets and Market Research

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Business Analysis and Decision-Making

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Global Business

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Business Analysis and Decision-Making

Payback period and average rate of return

2 things to know
A2 Unit 3

Overview

Investment appraisal, payback period and formula for the average rate of return.

What you need to know

Answer each one before you reveal it.

Your recallNot started

Key term

What is investment appraisal?

Key term

State how the fraction of a year in a payback period is converted into months.

Questions from this subtopic

Each one with the model answer underneath.

1
What is investment appraisal?
Model answer
Investment appraisal is the process of assessing whether a proposed capital investment is financially worthwhile before committing to it.
2
State the purpose of investment appraisal.
Model answer
It compares the cost of an investment with the returns it is forecast to generate, so that scarce funds go to the projects offering the best return for the risk.
3
Define the payback period.
Model answer
The payback period is the length of time it takes for the net cash inflows from an investment to cover its initial cost.
4
State how the fraction of a year in a payback period is converted into months.
Model answer
Divide the cash still to be recovered at the start of the year by that year's inflow, then multiply by 12.
5
A machine costs £240,000 and generates net cash inflows of £80,000, £100,000, £120,000 and £120,000 over four years. Calculate the payback period.
Model answer
£180,000 is recovered by the end of year two and the remaining £60,000 takes half of year three, so payback is 2 years and 6 months.
6
A project costs £150,000 and generates inflows of £50,000, £50,000, £60,000, £60,000 and £60,000. Calculate the payback period.
Model answer
£100,000 is recovered in two years and the remaining £50,000 takes ten months of year three, so payback is 2 years and 10 months.

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