Section D - Important concepts

[Tia]

Hi,

Here are some need to knows for Section D - Investment Appraisal:

(A) Investment appraisal and authorisation
 Quantify costs and benefits
 Compare costs and benefits using appropriate techniques
 Evaluate risks involved and sensitivity
 Consider qualitative factors
 Take a decision: (i) independent project, (ii) mutually exclusive projects

(B) Cash flows are relevant if they:
 Occur as a direct result of an investment
 Are incremental in nature
 Will occur in the future
 Are not sunk costs or interest costs
 Incremental working capital and opportunity costs are relevant
 Fixed costs are relevant to the extent they are incremental



Return on capital employed = (Average annual accounting profits X 100 ) / Average investment

[Keyperson]

There has 4 main areas on Part D - Investment Appraisal

1) Financing decision & Evaluation decision

Financing decision - Company should buy or lease asset.

Evaluation decision - Whether a proposal should be undertake.

2) Uncertainty

Using 2 approach to handle the uncertainty on investment appraisal. There are sensitivity analysis & Expected value.

3) Capital Rationing.

Company has insufficient money / capital to undertake all profitable projects. So only the most profitable project will be undertake & less profitable project will not be undertake.

4) Replacement policy

When is the best timing to replace a fixed asset. If the lifespan of a fixed asset is 3 years, then there has 3 options on replacement policy.

Option 1 : Replace the fixed asset annually.
Option 2 : Replace the fixed asset every 2 years.
Option 3 : Replace the fixed asset every 3 years.