IB Business and Management (Standard Level) All material taken from the IB Business and Management Textbook: "Business and Management", Paul Hoang, IBID Press, Victoria, 2007

1. IB Business and Management Unit 3.2: Investment Appraisal Lesson 1: Quantitative and Qualitative investment appraisal methods pp. 349-353

2. 1a. Think about it… “Never let a poor man advise you on investments.” – Spanish proverb Why not? What is an investment? The purchase of an asset with the potential to yield future financial benefits. Basically, it is something you buy that you hope will make you money. Can you think of some investments? What makes these investments good or bad? …

3. 1b. Think about it… What is an investment appraisal? Is the quantitative (means in this case dealing with numbers) techniques used to calculate the financial costs and benefits of an investment decision. There are four main appraisal methods: 1. Payback period (standard level) 2. Accounting rate of return (standard level) 3. Discounted cash flows (Higher level) 4. Net present value (Higher level) Since this is a standard IB course, we will be focusing on 1 and 2. …

4. 2a. Payback period It is the period of time for an investment to earn enough profits to repay the cost of the investment. The formula: initial investment($) contribution per month($) So your firm buys a new printing machine at a cost of $20,000. It brings in $12,000 in revenue each year. What would the payback period be? Lets work it out: initial investment ($)  $20,000 = ? contribution per month($) ($12,000/12 months) Answer is: 20 months. Now, which would you rather have, a shorter or a longer payback period? Why? Something else to consider when investing: 1.Will the income stream from the investment be constant each year? 2. You can see an example of this: The cumulative cash flow method on page 351 in your text.

5. 2b. Payback period Advantages disadvantages Quick and easy to use. Useful if your firm has a cash flow problem. Allows you to see the break-even on the purchase before it needs to be replaced. Used to compare different investments: looking for the quickest payback period. Asses projects that yield quick returns (profits) for investors. Assess the short term, less forecasting errors. May cause short-termism: you may focus only on short term investments. Monthly contributions will vary and will not be constant. This method focuses on time and not on profits…which is the major aim of most businesses. …

6. 3a. Accounting rate of return This method calculates the average profit on an investment as a % of the amount invested. The formula: APR = total profits during projects / number of years of projects x100 initial amount invested ($) Why is this useful? The APR allows you the manager, to compare the rates of returns on other investment projects. Used to assess the risks and rewards involved in an investment. For example: if an APR is 12% on a project vs. 4% in interest rate on savings, the real rate of return is 8%. So it might be worth the risk to invest on the project vs. to saving your money. Turn to page 353 in your text for another example on how to calculate APR.

7. 3b. Accounting rate of return Advantages disadvantages Enables easy comparisons of different investment projects. You are looking for the investment which provides the most return for less money invested. It ignores the timing of cash inflows. Prone to forecasting errors. …

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