Making Investment Decisions - PowerPoint Presentation

Slide1

Making Investment Decisions

A2 Business StudiesSlide2

Aims and Objectives

Aim:

To understand the payback investment appraisal technique

Objectives:

Define investment and investment appraisal

Describe the uses of investment appraisal

Calculate payback period.

Analyse payback period.Slide3

Starter

In pairs define:

Investment appraisal

In pairs decide on why investment appraisal may be important.

LO1:

Define investment and investment appraisal.Slide4

Investment Appraisal

Definition Investment:

Decision to spend an amount of money on something that will benefit the business in long run. E.g. fixed asset, stakes in another business

Definition Investment Appraisal:

The process of analysing the financial benefits of a possible future investment.Slide5

Investment Appraisal

Importance of Investment Appraisal:

Investment is important, as it may help achieve objectives, particularly a growth strategy.

Appraisal is important to judge the benefits of an investment decision and to judge the investment decisions of managers.Slide6

Making Investment Decisions

Two major considerations for managers when making investment decisions:

Total profits earned by the investment over the foreseeable future.

How quickly will the investment recover it’s cost?Slide7

Investment Appraisal TechniquesSlide8

Investment Appraisal TechniquesSlide9

Payback Method

Definition:

Calculates how long it will take to recoup (get back) the initial investment.

Note:

Before calculating any investment appraisals, tables must be drawn up to show net cash flow for each option.Slide10

Payback Method

Step 1:

Add up net cash flows of Machine A until there is enough to cover the initial investment.

Initial Investment = £750,000

£142,000 + 192,500 + 252,500 = £587,800 = Not enough to cover initial investment

£142,000 + 192,500 +

252,500 + 252,500 = £840,000 = Enough to cover initial investmentSlide11

Payback Method

£

142,000 + 192,500 +

252,500 + 252,500 = £840,000 = £840,000 recouped after 4 years, but we want to know when £750,000 is paid back….

Therefore

:

By year 4 enough money has come in from the new machine to cover the initial investment of £750,000.

However this is not accurate in terms of calculating months. £840,000 - £750,000 = £90,000 over

Payback is therefore 3 years and ‘x’ months.Slide12

Payback Method

Step 2:

Add up net cash flows of Machine A until end of year 3.

(we know the payback period falls between year 3 and year 4, but not in which month)

£142,000 + 192,500 + 252,500 = £587,800 = Year 3 Total Net Cash FlowSlide13

Payback Method

Step 2:

Initial Investment minus Year 3 total cash flow.

£750,000 – £587,800 = £162,200 = Remaining cash needed to pay back the investment in year 3.

Remaining Cash

x12

Net

Cash Flow In Year Calculated in Step 1Slide14

Payback Method

Step 3:

Calculate the month in which investment can be paid back.

£162,200

x12

£252,500

= 7.7 months, rounded up to 8 monthsSlide15

Payback Method

Step 4:

The payback period is therefore three years and eight months. Slide16

Payback Method

Task:

Calculate the payback period for Machine B.

Analyse which option as managers of Walkers you should chose and why.Slide17

Payback Period Analysed

Benefits of Payback Method

Shorter the payback period the less risky the investment, the quicker it can generate profits from its’ investment.

Good to use if business has cash flow problems, or if investment is in assets which outdate quickly.

Important to use if investment funded by external finance.Slide18

Payback Period Analysed

Drawback of Payback Period

Fails to look at cash flows after the payback period, ignoring overall profitability of the investment.

Assumes that in the year of payback the inflow of cash is steady across the year, which may not be true.

Especially for seasonal businesses!