3.8 Investment Appraisal

Assessing the value of an investment

What is an investment?

The act of committing money or capital to an endeavour with the goal and expectation of obtaining additional income and profit.

Definition: Investment Appraisal

Investment appraisal is the process of businesses evaluating whether an investment is attractive and profitable.

Or, where alternatives exist, which option is likely to be the best.

  • Using investment appraisal essentially allows a company to compare 2 or more potential investments

Investment Appraisal Tools:

  • Least initial cost (IC)

  • Total sum of predicted profit

  • Fastest ROI (payback period/ PBP)

    • Literally just the fastest return on profit

  • Most valuable return per year (ARR)

  • Most valuable given inflation (NPV)

    • Present value ≠ Value of money when you get a return

    • Discount rate is given in the exam (assumes discount rate stays the same)

    • Starts at year 0

Acronym Helper:

PBP = PayBack Period

ARR = Average Rate of Return

NPV = Net Present Value

IC = Initial Cost

IRR = Internal Rate of Return

Source: IB Business Management Syllabus (2016 - 2022)

"Using a different method is bound to get you a different answer" - Mr E. Owen (circa 2018)

Net Present Value

Net Present Value is the current monetary value of a product, or cash.

For example: in Jan 2018, a $100 would be worth $90 by Jan 2019.

This can be calculated through: Future Value = Present Value * (1 + r)^n

where r = rate of return, n = number of paying periods (annual, bi-annual, quarterly, monthly etc)

n = # of Paying Periods:

Annual = 1

Bi Annual = 2

Quarterly = 4

Monthly = 12

Daily = 365

Practice Questions:

Practice Question 1:

A CEO of a company wants to find out the future value of the land of one of it's assets after 5 years. Present value is $1,500,000. Due to the nature of land, it tends to appreciate annually by 5%.

Calculate the Future Value?

Practice Question 2:

See the question image to the right -->