10.3 Investment Appraisal

2026 Syllabus Objectives

By the end of these notes, you should be able to:

  1. Explain why investment appraisal is needed
  2. Understand, calculate, and interpret Payback Period and ARR
  3. Understand, calculate, and interpret NPV (Net Present Value)
  4. Explain how quantitative results affect investment decisions
  5. Explain how qualitative (non-financial) factors affect investment decisions
  6. Compare all three investment appraisal methods, including their limitations

1. The Need for Investment Appraisal

https://cambridgeassistant.com

What is an investment?

An investment is when a business spends a large amount of money now, hoping to earn more money back in the future. For example, a business might spend $500,000 on a new machine, expecting that machine to help them earn more over the next five years.

Why can't businesses just guess?

Investments involve huge sums of money. If the decision turns out to be wrong, the business could lose a lot of money and even go bankrupt. This is why businesses use investment appraisal — a set of methods that help them examine whether an investment is likely to be worth it before they spend the money.

What does investment appraisal do?

Investment appraisal helps a business answer two key questions:

  • How quickly will we get our money back? (Speed of repayment)
  • How profitable will the investment be? (Overall return)

What data is needed before appraising an investment?

Before a business can appraise an investment, it needs to gather important information, including:

  • Sales forecasts — How much do we expect to sell?
  • Cost data — What will the fixed and variable costs be?
  • Pricing information — What price will we charge?
  • Borrowing costs — If we need to borrow money, how much interest will we pay?

Gathering and making sense of this data takes time and requires experience. Getting it wrong means the appraisal results will be unreliable.

The three main methods

There are three main investment appraisal methods:

  1. Payback Period
  2. Average Rate of Return (ARR)
  3. Net Present Value (NPV)

Each method looks at the investment from a different angle. Most businesses use more than one method to get a fuller picture.

Sign in to view full notes