ZIMSEC A Level · Accounting · Form 6
Investment appraisal helps choose between long-term projects.
Payback period
Time taken to recover the initial investment from net cash inflows.
Worked example: Investment US$10 000; inflows US$4 000 a year for 4 years. Find the payback.
After 2 years: 8 000 recovered; remaining 2 000 ÷ 4 000 = 0.5 year → payback 2.5 years
Simple and favours liquidity, but ignores cash flows after payback and the time value of money.
Accounting rate of return (ARR)
ARR = average annual profit ÷ average investment × 100, where average investment = (initial cost + residual value) ÷ 2. Uses profit, not cash, and ignores timing.
Net present value (NPV)
Discount future cash flows to present value using the cost of capital. Accept if NPV is positive.
Worked example: Investment US$10 000; inflows US$4 000 for 3 years; cost of capital 10% (discount factors 0.909, 0.826, 0.751). Find the NPV.
PV = 4 000 × (0.909 + 0.826 + 0.751) = 4 000 × 2.486 = 9 944
NPV = 9 944 − 10 000 = −US$56 → reject on financial grounds
Internal rate of return (IRR)
The discount rate at which NPV = 0, found by interpolation. Accept if IRR exceeds the cost of capital.
Non-financial factors
Environmental impact, effects on staff, reliability of forecasts, strategic fit and legal requirements.
Check yourself
- Which method ignores cash flows after the investment is recovered?
- What decision rule applies to NPV?
- An inflow of US$5 000 in one year at 10% has what present value?
Show answers
- The payback method.
- Accept projects with a positive NPV (choose the highest among alternatives).
- 5 000 × 0.909 = US$4 545
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