IB Business Management: Investment Appraisal

Introduction

Definition: Time it takes to recover the initial investment.
Calculation Steps:
- Add a column for recovery of investment to track remaining amount each year.
- Example: If £10,000 remains in year 2 and £20,000 inflows in year 3, then payback is calculated as ( \frac{10}{20} \times 12 ), resulting in 6 months.
- Total payback = 2 years 6 months.
Application: Helps decide between competing projects based on time to recover investment.
Criticism:
- Simple and easy to calculate.
- Ignores profits after payback period.
- May miss out on more profitable investments.

Formula: ( \frac{\text{Total Return (Cash Flows) - Initial Investment}}{\text{Initial Investment}} \times 100 )
Concept: Similar to interest rate in savings.
Decision: Choose project with highest ARR.
Considerations:
- Check if ARR meets minimum return targets set by the business.
- Longer project duration may reduce reliability.
Example: Project B with higher ARR is preferable.

Significance: Takes into account the time value of money.
Concept: Adjusts future cash flows for inflation to reflect today's value.
Calculation:
- Use discount factors provided in exams.
- Multiply net cash flows by discount factor for NPV.
- Positive NPV indicates profit; negative indicates loss.
- Example: Invest £250,000; forecast £100,000 cash flow today worth less due to discounting.
Decision: Choose project with highest positive NPV.
Advantages: More reliable as it considers time value of money.

Evaluation Points:
- Balance quantitative and qualitative factors in decision-making.
- Payback or ARR may suggest different projects than NPV.
- Consider qualitative factors like stakeholder impact, ethics, and brand reputation.
Knowledge Check: Answer syllabus questions 1-8 to ensure understanding.