Investment appraisal

2017-18

OBJECTIVE

I criteria to choose among projects

INVESTMENT APPRAISAL

I Investment:I purchase of capital goodsI expenditure by business expecting to yield a future return

I Investment appraisal: objective evaluation of investmentproject→ compare capital cost of project with net cash flow

I capital cost: money spent when setting up new ventureI net cash flow: cash inflows minus cash outflows

SIMPLE PAYBACKI Payback period: amount of time it takes for a project to

recover or pay back the initial outlayI Payback period can also be found by calculating the

cumulative net cash flow

year 0 : − 500 000 initial investment

year 1 : + 100 000 cash flow

year 2 : + 125 000 cash flow

year 3 : + 125 000 cash flow

year 4 : + 150 000 cash flow

WORKED EXAMPLE

ADVANTAGES OF THE PAYBACK METHOD

I rapid technological change: recover cost of investment beforenew model/eqipment is designed

I simple to useI cash-flow problems: chosen project will payback investment

faster

AVERAGE (ACCOUNTING) RATE OF RETURN (ARR)

ARR (%) =net return (profit) per annum

capital outlay (cost)× 100

WORKED EXAMPLE

WORKED EXAMPLE

ADVANTAGES OF THE ARR METHOD

I shows the profitability of an investment projectI comparability

DISCOUNTED CASH FLOW (NET PRESENT VALUE OR

NPV)

I present value of future cash flow or future profit earnedI Value of 100 invested over 5 years at 10% per annum

compound interest:I in one year: 100× (1 + 0.1) = 110I in two years: 110× (1 + 0.1) = 121

DISCOUNTED CASH FLOWDISCOUNT TABLES

discount tables: shows by how much a future value must bemultiplied to calculate its present value

ADVANTAGES OF THE DISCOUNTED CASH-FLOW

METHOD

LIMITATIONS OF THESE TECHNIQUES

KEY TERMS

I Average rate of return or accounting rate of return (ARR):a method of investment appraisal that measures the netreturn per annum as a percentage of the initial spending

I Capital cost: the amount of money spent when setting upa new venture

I Discounted cash flow (DCF): a method of investmentappraisal that takes interest rates into account bycalculating the present value of future income

I Investment: the purchase of capital goodsI Investment appraisal: the evaluation of an investment

project to determine whether or not it is likely to beworthwhile

KEY TERMS

I Net cash flow: cash inflows minus cash outflowsI Net present value (NPV): the present value of future

income from an investment project, minus the costI Payback period: the amount of time it takes to recover the

cost of an investment projectI Present value: the value today of a sum of money

available in the future

KEY TERMSREVISION OF CHAPTER 17

I Bonus: A payment in addition to the basic wage forreaching targets or in recognition for service

I Commission: Percentage payment on a sale made to thesalesperson

I Consultation: Listening to the views of employees beforemaking key decisions that affect them

I Delegation: The passing of authority further down themanagerial hierarchy

I Empowerment: Giving official authority to employees tomake decisions and control their own work activities

I Hawthorne effect: The idea that workers are motivated byrecognition given to them as a group

KEY TERMSREVISION OF CHAPTER 17

I Hygiene or maintenance factors (Herzberg’s): Things atwork that result in dissatisfaction

I Job enlargment: Giving an employee more work to do of asimilar nature; ’horizontally’ extending their work role

I Job enrichment: Giving employees greater responsibilityand recognition by ’vertically’ extending their work role

I Job rotation: The periodic changing of jobs or tasksI Maslow’s hierarchy of needs: The order of people’s needs

starting with basic human requirementsI Motivated: The desire to take action to achieve a goal

KEY TERMSREVISION OF CHAPTER 17

I Hygiene or maintenance factors (Herzberg’s): Things atwork that result in dissatisfaction

I Job enlargment: Giving an employee more work to do of asimilar nature; ’horizontally’ extending their work role

I Job enrichment: Giving employees greater responsibilityand recognition by ’vertically’ extending their work role

I Job rotation: The periodic changing of jobs or tasksI Maslow’s hierarchy of needs: The order of people’s needs

starting with basic human requirementsI Motivated: The desire to take action to achieve a goal

KEY TERMSREVISION OF CHAPTER 17

I Motivators (Herzberg’s): Things at work that result insatisfaction

I Payment by results: Payment methods that rewardworkers for the quantity and quality of work they produce

I Performance-related pay (PRP): A payment systemdesigned for non-manual workers where pay increases aregiven if performance targets are met

I Piece rates: A payment system where employees are paidan agreed rate for every item produced

KEY TERMSREVISION OF CHAPTER 17

I Profit sharing: Where workers are given a share of theprofits, usually as part of their pay

I Scientific management: A theory that suggests there is a’best way’ to perform work tasks

I Self-actualisation: A level in Maslow’s hierarchy wherepeople realise their full potential

I Teamworking: Organising people into working groupsthat have a common aim

KEY TERMSREVISION OF CHAPTER 18

I Autocratic leadership: A leadership style where amanager makes all the decisions without consultation

I Democratic leadership: A leadership style wheremanagers allow others to participate in decision making

I Laissez-faire leadership: A leadership style whereemployees are encouraged to make their own decisions,within certain limits

I Paternalistic leadership: A leadership style where theleader makes decisions but takes into account the welfareof employees