10.3.1 The concept of investment appraisal
Definition Investment appraisal is the evaluation of the profitability or desirability of an investment project, using quantitative techniques and qualitative judgement.
The need for investment appraisal
- investments — new machinery, factories, products, IT systems, acquisitions — involve large sums committed for many years
- they are often difficult to reverse: a specialist factory cannot easily be sold
- capital is scarce, so the business must choose between competing projects (opportunity cost)
- future returns are uncertain — appraisal assesses risk as well as return
- lenders and shareholders expect investments to be justified
Investment appraisal compares the initial cost of a project with its forecast net cash flows (cash inflows minus cash outflows) over its life. These forecasts are estimates — the further ahead, the less reliable.
🔒 Also in the full notes
- 10.3.2 Basic methods: payback, accounting rate of return (ARR)
- 10.3.3 Discounted cash flow method: net present value (NPV)
- 10.3.4 Investment appraisal decisions
- Exam practice: 5 practice questions
- 2 exemplar answers with full model answers and mark breakdowns
- Where students commonly lose marks
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