hi the first of many revision videos to help students of ib business management there are three quantitative methods you'll be expected to use to undertake investment appraisal the first one is the payback period that simply is look for the project which allows you to recover your money in the shortest amount of time now example in front of you takes you through and shows you how to calculate it personally i always recommend students to put in the third column recovery of investment so you have a running total of how much is left at the end of each year to recover from the initial investment and you can see in this example and if you have two there's only ten thousand remaining and in year three there's twenty thousand cash inflows to the business net cash inflation i should say uh so really just ten over 20 times 12 because you're looking to work out the number of months it will take during year 3 to recover that 10 000 pounds and so that gives you there for six months so total payback is two years six months so have a look at the examples see if you can follow the logic of how it's calculated understand mechanics first then move on to why you're actually basically taking the process the key terminology is relatively straightforward investment appraisal is simply a tool which allows businesses to make decisions decisions on competing alternatives you have a fixed amount of money and these examples normally are replacing company cars for the business the variety of different brands of cars out there which brand do you actually take so investment appraisal will allow you to look at the quantity of the number and the quality of factors and add those two together that should therefore allow you to make the optimum decision on which investment to undertake so here moving on to work example two you've got two competing projects and simply just follow the process previously outlined and you can see that project a allows you to recover your money your initial investment in a shorter amount of time in project b so according to theory project a on quantitative number basis is a project you should select now let's take your understanding a step further evaluate what has gone on thus far and how you can actually criticize the payback period method yes it's easy to calculate simple to understand but ignores profits after payback if you work through the calculation here and the last two points in particular you can see that the technique tells you to select project a because you can recoup your money in the shortest amount of time compared to project b however project b if you add together all net cash flows over the lifespan of the project will be far more profitable so therefore for the sake of recouping your money in a short amount of time you could actually miss out on a far more profitable investment second quantitative method the average rate of return and this is the formula given in the ib syllabus uh breaking down it's simply arr total return so say that's all the cash flows added together capital cost initial investment lifespan of project number of years divided by your initial investment and express the answer percentage some students are confused by the idea of a rate of return think about if you put money in a bank and the bank pays you interest on your savings that's simply the interest rate is the rate of return so here you're looking for a gain or a loss on an investment and all you do is basically express that gain or loss in terms of a percentage and the bottom line with arr is you select the project with the highest ar figure but you need to take into account the game from an evaluation point of view some businesses will have minimum return on investment targets so always carefully read exam questions yeah if this is specified and you work out yeah for one or two three different projects and you say select project a for example but in project a still below the target investment businesses will not normally touch an investment which does not reach their minimum threshold in terms of target so realistically that is the only factor that normally causes a problem criticisms of the method is involving averaging so the longer the time span of the project uh the longer you average over and therefore less reliable on figures a simple work example just follow it through make sure you're happy with the idea that obviously project b has a far higher return so therefore that's a project which should be selected on numerical quantitative basis moving on to the third quantity method discounted cash flow net present value mpv note is hl only this method now the primary reason stroke advantage of using npv is that it takes into account the time value of money something which neither the payback period or arr actually does now time value money is basically inflation which is purchasing power if you are undertaking investments you have to forecast the returns on that investment so if you are forecasting the investment will generate a net cash flow of a hundred thousand pounds in five years time one hundred thousand pounds will buy in five years time compared to today has to be adjusted because the purchasing power in five years time hundred thousand pounds will not buy you the same amount of goods or services the hundred thousand pounds does today so you get involved in something called discounting and this will come you know far more obvious as i take you an example worked example now students again for some reason find this terribly difficult to start off with it's simply a matter of laying out your data in columns so you've got the year you've got the net cash flow you've got discount factors you've got net present value now discount factors okay if there is a question in examination ib will provide you with table of discount factors you just have to find out which percentage discount factor to use and it will be specified in a question or they may not even give you the table so just basically print them in exam paper here i'm using a four percent discount factor so you take the net cash flows you multiply them by the discount factor to rise arrive at the net present value so you invest 250 000 pounds in one year's time you're generating that cash flow okay 100 000 pounds but what you're actually saying you have to discount to reduce it that hundred thousand pound in 12 months time is only worth percent of its value so therefore today it's only worth ninety six point one five okay now workout is paying thousands in two years time you forecast you this project will generate 120 000 pounds but what is that worth to you today that's only worth 92.46 of its value so what you actually do here the calculation is multiply cash flow by the discount factor to arrive at net present value and that present value is what are those future cash flows worth today so you are discounting you are reducing the future cash flows so two hundred thousand pounds in four years time is only worth eighty four five point four eight percent of its value today now all you simply have to do cash flow multiplied by discount factor gives you mpv at the pool of the inflows net cash flows then subtract the outflow that's initial investment you end up with an mpv okay this is all detailed in red so go back over and work this through yourself and what you're seeking if you've got two three different projects calculate mpvs you're looking for the project with the highest positive mpv now what this actually means is in today's terms as it says here yeah 296.972 okay that is the profit the value of the profit this project so business spends 250 000 okay it's going to generate over the four years okay 296 972 so that is the value of the profit in today's terms so the point of discounting is you're making decision today which is zero so therefore future cash flows what are they worth to you today to make decision today have the values of the cash flows today and work out the relative profits so if it's positive the npv it's a profit if it's negative you make a loss if it's zero you will basically break even on a projected investment theory wise take a look through this yourself it basically just goes over what i've just basically said for the previous slide to bonus with you um so it should be relatively straightforward so let's draw this together in terms of some evaluation points exam questions will always expect you to look at both quantitative and qualitative analysis of investment options this is all about decision making so you will have to balance number and non-number factors and arrive at a conclusion of which option is the best way forward for a business look out for the fact payback arr may suggest one option mpv another that's not an issue it's just the way you balance it's a quality of your analysis evaluation draw into the facts also mpv is the more reliable method it takes into account the time value of money also look for payback are you foregoing a project which over its lifespan could be more profitable than the one you're actually taking qualitative user integration on your business an investment may be highly profitable but look at your stakeholders are you looking to place workers with technology how would that impact on your brand what about motivation levels of the workers left behind lack of impact on your labour turnover as well those workers may not have lost their jobs at that point but they may think well it's only a matter of time so they leave also remember profitable investment link it to ethics it may be profitable for investing in certain products certain countries okay is that actually ethical and again take that back to your brand final item for you is a quick knowledge check and what you have here questions one two eight are the syllabus requirements for ib business management 3.8 so if you can answer questions one two eight you understand all the knowledge then it's just a matter of going back and practice practice practices find your examination questions i hope this has been useful it's on the youtube channel make sure you keep your eyes open subscribe to our channel there will be more coming