Investment Evaluation Methods

Limiting Factor Definition

• A factor of production that restricts the level of activity or output quantity.

Provision Definition

• A liability with uncertain timing or amount.

Net Present Value (NPV)

• Pros: Accounts for the time value of money, thus incorporating inflation.
• Cons: Determining the cost of capital for NPV calculation can be challenging and subjective, potentially leading to inaccuracies.

Payback Method

• Pros: Simple to calculate and understand, making it manager-friendly.
• Cons: Ignores profits after the payback period.

Average Rate of Return (ARR)

• Pros: Focuses on profit, a crucial business objective.
• Cons: Does not account for the time value of money, overlooking inflation.

Internal Rate of Return (IRR)

• Definition: The percentage return an investment is projected to yield over its life.
• Profitability Criteria: Must exceed the weighted average cost of capital (WACC) for profitability.
• Pros: Enables comparison of projects with varying lifespans as it's the discount rate making NPV zero.
• Cons: Complex, potentially not easily understood by non-financial personnel.

Profitability Index

• Pros: Allows return comparison across different projects, even with varying sizes.

Decrease in Inventories

• Pros: Reduced warehousing and security costs.
• Cons: Limited inventory, potentially hindering large order fulfillment.

Decrease in Trade Payables

• Pros: Improved credit rating with suppliers, facilitating future credit acquisition.
• Cons: Reduced liquidity for other business activities.

Share Purchase in Another Company

• Reasons:
  • Anticipated future share price increase, promising profit potential.
  • Seeking control over suppliers or other companies.

Additional Share Issue Reasons

• Primary Purpose: Raising capital.
• Secondary Effect: Reducing the gearing ratio.

Budget Preparation Process

• Phase 1: Identify limiting factors affecting other budgets (e.g., production).
• Phase 2: Consult relevant departments for realistic figures and feedback.
• Phase 3: Develop a comprehensive master budget.

Goodwill Determination Factors

• Key Factor: Annual profits (higher profits = higher goodwill).
• Other Considered Elements: Company reputation and brand awareness (better reputation = higher goodwill).

Marginal vs. Absorption Costing

• Marginal Costing:
  • Allocates costs to time periods, potentially providing a more accurate profit picture.
  • May align with the prudence concept by showing lower inventory values.
• Absorption Costing:
  • Traces costs to products, useful for assessing product profitability.
  • Aligns with matching costs to earned revenues for specific products.

Stock Record Card

• Pros: Provides clear overview of receipts, issues, and balances, minimizing theft. Shows low stock points for timely reorders.
• Cons: Tracks issues, not consumption by production. Requires constant updates to avoid variances.

Share Premium Account Uses

• Bonus Share Issuance: Funding bonus share allotments.
• Share Redemption Premiums: Paying premiums for share redemptions.
• Preliminary Expenses Write-off: Writing off formation expenses when a company is set up.

ICT Use in Business (Financial, Technical, Human aspects)

• Financial:
  • Pros: Streamlines financial transactions, potentially reducing accountant costs for annual profit & tax calculations.
  • Cons: Expensive initial hardware/software investment, ongoing support, updates, training.
• Technical:
  • Pros: Improves record-keeping, reduces errors with double-entry bookkeeping and automated financial statements.
  • Cons: Unnecessary for low volume, potential data loss risk (crashes, power outages).
• Human:
  • Pros: Reduces workload, rewarding for implementation.
  • Cons: Learning curve, potentially frustrating implementation difficulties.

Budget Evaluation

• Pros:
  • Forecasting (management control).
  • Planning (coordination).
  • Control (variance analysis).
• Cons:
  • Inaccurate forecasting.
  • Costs outside management control (e.g., rent).

Project Appraisal Evaluation Criteria

• NPV: Positive or negative values.
• ARR: Above or below cost of capital.
• Payback Period: Within or exceeding expected project lifespan.
• Gearing Ratio: Highly geared, +/- 50%, plus or minus.
• Profitability Index: Above or below 1.

Standard Costing Evaluation Criteria (Variances)

• Labor efficiency.
• Labor rate.
• Material usage.
• Material price.

Auditor Role Evaluation - 5 Key Roles

• Leadership: Assessing responsibility structure (e.g., CEO/chairman).
• Effectiveness: Ensuring regular board member reelections.
• Accountability: Evaluating risk management procedures.
• Remuneration: Checking compensation policies.
• Shareholder Relations: Assessing shareholder meeting procedures.

Share Redemption Evaluation

• Pros: Potentially improved Return on Capital Employed (ROCE).
• Cons: Reduced future dividend payout, worsened gearing, reduced liquidity.

Purchase on Credit Evaluation

• Pros: Increased sales, expanded customer base.
• Cons: Potential for bad debts, costly legal disputes, insurance costs.

Merger Evaluation

• Pros: Diversification, expansion, economies of scale, higher profits.
• Cons: Goodwill paid, potential dilution of ownership (if shares are used in payment).

Earning per Share Improvement Methods

• Increase net profit.
• Reduce interest payments (e.g., paying off loans).
• Reduce tax rates (e.g., relocation).
• Reduce number of ordinary shares.

Gearing Ratio Evaluation

• Evaluation: Beneficial use of debt?
• Potential Concerns: Reduced profits, interest payments, repayment risk (collateral loss, insolvency).

Dividend Payments Evaluation

• Pros: Satisfied shareholders, encouraging existing and potential investors and maintaining control.
• Cons: Reduced cash available for other activities, possibly impacting liquidity.
• Additional: Dividend cover (sufficient profits to cover) and dividend per share/yield.

Debentures Evaluation

• Pros: Lower interest rates compared to some bank loans, potentially accessible to less creditworthy firms.
• Cons: Required collateral (possible loss), interest payments occur frequently (at 6-month intervals).

Liquidity Performance Evaluation

• Analysis Points:
  • Healthy cash/cash equivalents.
  • Current ratio (e.g., 2:1 or 1:1).
  • Acid-test ratio (e.g., 0.9:1).
  • Comparison across time periods.
  • Impact of events (loan repayments, profit growth).

Disclosure of Discontinued Activities Evaluation

• Pros: Better prediction of future performance, true & fair view.
• Cons: Financial statement complexity, increased time and cost.

Flexible Budget Evaluation

• Pros: Improves decision-making by comparing different output levels, saving time/money by analyzing variances, and predicting revenue and costs under varying sales levels.
• Cons: Time-consuming to construct flexed budgets, potential for estimation/guesswork issues & inaccuracies.

Bonus Shares vs. Final Dividends Evaluation

• Bonus Shares: Retain internal funds, no external outflow.
• Final Dividends: No share dilution, potentially increased share price due to dividend yield.

This quiz explores various investment evaluation methods such as Net Present Value, Payback Method, Average Rate of Return, and Internal Rate of Return. Understand the pros and cons of each approach as well as key financial concepts related to investments.