Investment Appraisal
There are four steps in the investment decision:
- Identify investment opportunities
- Put numbers to each opportunity (this is the most difficult part!)
- Evaluate and make a decision (NPV calculation)
- Monitor investment and control
In point 3, how to make a decision, there are 3 possible analyses:
- PAYBACK PERIOD (ignores time value of money and ignores cash flows after payback period)
- INTERNAL RATE OF RETURN (good to compare, but doesn’t allow + – + flows bc of maths error)
- NET PRESENT VALUE (forces you to get WACC, considers time value of money and has not maths problems).
Decision criteria:
- Choose project that maximizes NPV
- Choose project in which IRR is higher than WACC
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CFO’s objective: MAXIMIZE SHAREHOLDERS VALUE (while complying with law and ethic values):
a. Do not run out of cash! Cash-flow management.
b. Make good investment decisions!
c. Make good financing decisions!
Tags: internal rate of return, investment appraisal, investment decision, investment opportunities, IRR, net present value, NPV, PAYBACK