“Year of the Strengthening of National Sovereignty”

METHODOLOGICAL DESIGN FOR LEARNING - BUSINESS MANAGEMENT SL – 5TH YEAR – UNIT N°2
MDFL N° 07: INVESTMENT APPRAISAL

1. WE GET IN TOUCH AND TAKE ON CHALLENGES (15 MINUTES)

¡Hello! Welcome dear students. Thank you for joining to my class. I hope you enjoy the Business
Management topic of today, and I will be available for all your comments and doubts. Thanks at
all!!

Note. Retrieved from Investment appraisal Explained, by Sense Business Studies, February 19th, 2018. https://www.youtube.com/watch?v=AZRIy2bmoeI

What is an investment? What is the definition of investment appraisal? What is the average rate of
return? What are the advantages of the average rate of return? What are the disadvantages of the
average rate of return?

Do you think there are attractive inclusive businesses to invest in? Why?

Do you think that the same factors are considered in different countries to evaluate an investment?
Why?

Next, we present the challenge, the missions and the goal of this session:

Challenge Goal Evaluation

Missions
[Evidence] criteria
[Purpose] [Activities]

✔ Review the attached 1. Define the term ‘investment

information. appraisal’.
2. Calculate the payback periods
✔ Summarize the
Evaluates investment for Project X and Project Y.
information about
opportunities using Study case: Ashton 3. Calculate the ARR for Project X
investment appraisal and
payback period and Textiles Ltd Plans an and Project Y.
answer the questions.
average rate of return investment 4. Based on financial and
(ARR) to select ✔ Solve exercises related to
non-financial factors
investment alternatives. investment appraisal.
evaluate whether Ashton
✔ Elaborate the evidence. Textiles Ltd should choose
✔ Reflect on your learning. Project X or Project Y.

TRANSVERSALIZATION WITH THE COMPONENTS OF THE DP

In this MDFL, we are going to work on the links with the components of the DP through the following activities:
Components of the DP Activity 1 2 3 4 5
When we answered knowledge questions (We contact each other and take on challenges, x x
ToK (Critical and we conclude the understandings).
thinking)
When we investigate the material provided and organize the development of the x
Extended Essay investigation in the form and time to carry out the proposed activity (We research and
(Inquiry) build learning).

CAS (Projection toward We work on learning outcomes of CAS when we work as a team, plan activities, persevere x x
the community) and, identify our strengths and weaknesses. (We transfer and self-evaluate, and we
reflect on our results).

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When we answered knowledge questions (We contact each other and take on challenges, x x
Interculturality and we reflect on our results).

When we answered knowledge questions (We contact each other and take on challenges, x x
International
and we reflect on our results).
mentality
When the teacher mediates the teaching-learning process throughout the class, providing x x x x x
Pedagogical
scaffolding to the student. (During all session processes).
Principles

2. WE INVESTIGATE AND BUILD LEARNINGS (80 MINUTES)

Activity 01: Guess what! Discover some business terms and connect with their definition.
Payback period a. ………………………….is the purchase of an asset with the potential
to yield future financial benefits.
Investment b. …………………………… is the quantitative (means in this case
dealing with numbers) techniques used to calculate the
financial costs and benefits of an investment decision.
Investment Appraisal c. ………………….is the period of time for an investment to earn
enough profits to repay the cost of the investment.

Are you ready now? As you read, take note in the margins of the text of
everything that generates doubts, questions, curiosity. If you have the
possibility, enrich this reading by searching other sources to clarify your
concerns and curiosities. Remember to learn you must link the knowledge
and inquire to master the new knowledge.

Activity 02: Read the information about investment appraisal and answer the questions.

Reading purposes
- Understand and evaluate the payback period and the average rate of return as
investment appraisal methods.
.
INVESTMENT
● Investment means purchasing capital goods, such as equipment, vehicles and new buildings,
and improving existing fixed assets with the goal of generating income or appreciation.
● Many investment decisions involve significant strategic issues, such as relocation of premises
or the adoption of computer-assisted engineering methods.
● Other investment plans are less important to the overall performance of the business, such
as replacing worn-out photocopiers.
● Relatively, minor investment decisions will not be analyzed to the same degree of detail as
more substantial decisions on capital expenditure.
INVESTMENT APPRAISAL
● Refers to the quantitative techniques used in evaluating the viability, feasibility or attractiveness of
an investment proposal. Attempts to assess and justify the capital expenditure allocated to a
particular project. Aims to establish whether a particular business venture is worth pursuing and
whether it will be profitable. Also assists businesses in comparing different investment projects.
● Non-financial issues can also be significant and therefore qualitative appraisal of a project might also
be very important.

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● In some businesses, especially those dominated by the founding entrepreneur, formal investment
appraisal may not be applied.
● Instead, the owner may develop a ‘feel’ for what is likely to be most successful and go ahead with
the project even though no formal analysis has been undertaken.
● The use of such ‘intuitive’ or ‘hunch’ methods of taking investment decisions cannot be easily
explained or justified, unless they turn out to be very successful.
● Quantitative investment appraisal requires the following information:
● The initial capital cost of the investment, including any installation costs
● The estimated life expectancy – for how many years can returns be expected form the investment?
● The residual value of the investment – at the end of their useful lives will the assets be sold, earning
additional net returns?
● The forecasted net returns or net cash flows from the project – these are the expected returns from
the investment minus the annual running cost
All the techniques used to appraise investment projects require forecasts to be made of future cash
flows. These figures are referred to as net cash flows.
We assume for the IB examinations, that the cash inflows are the same as the annual revenues earned
from the project and the cash outflows are the annual operating costs.
● These net cash flow figures can then be compared with those of other projects and with the initial
cost of the investment.
● Forecasting cash flows is not easy and is rarely likely to be 100% accurate.
● With long-term investments, forecasts several years ahead have to be made and there will be
increased chances of external factors reducing the accuracy of the figures.
● Future uncertainties cannot be removed from investment appraisal calculations.
● The possibility of uncertain and unpredicted events making cash flow forecasts inaccurate must,
however, be constantly borne in mind by managers.
● All investment decisions involve some risk due to this uncertainty.
● For instance, when appraising the construction of a new airport, forecasts of cash flows many years
ahead are likely to be required. Revenue forecasts may be affected by external factors such as:
● An economic recession that could reduce both business and tourist traffic through the airport
● Increases in oil prices that could make air travel more expensive than expected, again reducing
revenue totals
● The construction of a new high-speed rail link within the country, which might encourage some
travelers to switch to this form of transport.
THE PAYBACK PERIOD
● Estimates the length of time required for an investment project to pay back its initial cost outlay.
● Looks at how long a business will take to recover its principal investment amount from its net cash
flows.
● Can be calculated using the following formula:
Payback period = Initial investment cost
Annual cash flow from investment

Example 1
● A construction engineer plans on investing $200,000 in a new cement-mixing machine and estimates
that it will generate about $50,000 in annual cash flow.
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● Calculate the payback period for the machine.
Payback period = 200,000 = 4
50,000
● Hence, the payback period for the new machine would be four years.
Example 2
● Another construction engineer aims to invest $300,000 in a new timber-cutting machine. The
machine is expected to generate the following cash flows in the first four years: $60,000, $80,000,
$100,000 and $120,000.
● Its payback period can be identified by calculating the cumulative cash flows over the four years, as
shown in the table below:
Year Annual net cash flows ($) Cumulative cash flows ($)

0 (300,000) (300,000)

1 60,000 (240,000)

2 80,000 (160,000)

3 100,000 (60,000)

4 120,000 60,000

● The initial investment outlay will be paid back sometime in year four – but in which month exactly?
● This can calculated using the following formula: •
Extra cash inflow required x 12 months
Annual cash flow in year 4

60,000 x 12 = 6
120,000
● The extra cash inflow is $60,000. This is because in year 3 it has been calculated that only $60,000
needs to be paid in year 4 to pay off the initial investment.
● The annual cash flow in year 4 is $120,000. Therefore, applying this to the formula we get:
• It therefore takes three years and six months to pay back the initial investment of $300,000.
Examples 1 and 2
• The results in examples 1 and 2 can be compared with results from other projects to aid decision
making.
• As a general rule, the shorter the payback period of the project, the better it is for the investing
business.
• The business may also have decided on an internal payback period or “cut-off” that an investment
should not go below, for example four years.
• In example 1, the investment project just meets this criterion while the one in example 2 is better
off by six months.
Importance of payback period
• The uses and benefits of the payback period technique include the following:
• A business may have borrowed the finance for the investment and a long payback period will
increase interest payments.

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• Even if the finance was obtained internally, the capital has an opportunity cost of other purposes
for which it could be used. The speedier the payback, the more quickly the capital is made available
for other projects.
• The longer into the future before a project pays back the capital invested in it, the more uncertain
the whole investment becomes. The changes in the external environment that could occur to make
a project unprofitable are likely to be much greater over ten years than over two.
• Some managers are ‘risk-averse’ – they want to reduce risk to a minimum so a quick payback
reduces uncertainties for these managers.
• Cash flows received in the future have less real value than cash flows today, owing to inflation.
The more quickly money is returned to an investing company, the higher its real value will be.
Advantages of payback period
• It is simple and fast to calculate.
• It is a useful method in rapidly changing industries such as technology. It helps to estimate how
fast the initial investment will be recovered before another machine, for example, can be
purchased.
• It helps firms with cash-flow problems because they can choose the investment projects that
can pay back more quickly than others.
• Since it is a short-term measure of quick returns on investment, it is less prone to the inaccuracies
of long-term forecasting.
• Business managers can easily comprehend and use the results obtained.
Disadvantages of payback period
• It does not consider the cash earned after the payback period which could influence major
investment decisions.
• It ignores the overall profitability of an investment project by focusing only on how fast it will
pay back.
• The annual cash flows could be affected by unexpected external changes in demand which could
negatively affect the payback period.
THE AVERAGE RATE OF RETURN
• Measures the annual net return on an investment as a percentage of its capital cost.
• Assesses the profitability per annum generated by a project over a period of time.
• Also known a the accounting rate of return.
• Can be calculated using the following formula:

(total returns – capital cost)

ARR = years of usage x 100
Capital cost

Example
• A business considers purchasing a new commercial photocopier at a cost of $150,000. It expects
the following revenue streams for the next five years: $30,000, $50,000, $75,000, $90,000 and
$100,000 respectively.
• Calculate its ARR.
Total returns = 30,000 + 50,000 + 75,000 + 90,000 + 100,000
= 345,000
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Net return per annum = (345,000 – 150,000) = 39,000

5

ARR = 39,000 x 100 = 26%

150,000
• The business therefore expects an ARR of 26% on its investment.
• A business can compare this figure with the ARR of other projects and choose the project
showing the highest rate.
• The ARR can also be compared with banks’ interest rates on loans, to assess the level of risk.
• For example, if banks offer an interest rate of 15%, businesses may find it worthwhile to pursue
investment projects with a return of 11% higher than the base lending rate.
• Other businesses set criterion rates or a minimum rate that an investment project should not go
below if it is to be selected.
• For example, if the criterion rate was 20%, the ARR is 6% above this rate and would still be
considered a desirable project to pursue.
Advantages of ARR
• It shows the profitability of an investment project over a given period of time.
• Unlike the payback period, it makes use of all the cash flows in a business.
• It allows for easy comparisons with other competing projects, for better allocation of
investment funds.
• A business can use its own criterion rate and check this with the ARR for a project, to assess the
viability of the venture.
Disadvantages of ARR
• Since it considers a longer time period or useful life of the project, there are likely to be
forecasting errors. Long-term forecasts decrease the accuracy of results.
• It does not consider the timing of cash inflows. Two projects might have the same ARR but one
could pay back more quickly despite this.
• The effects on the time value of money are not considered.
Install the Quizizz application on your cell phone or enter the following link:
https://quizizz.com/join
Wait for the teacher to give you the game code.

WE CONCLUDE THE UNDERSTANDINGS (30 MINUTES)

What is the meaning on Payback Period and ARR?

Why is it important to know Payback Period and ARR for organizations and new investments?
Do you think that one should be integral or supportive when evaluating an investment?

MODELING CASE (40 MINUTES): Read and analyze the study case and answer the questions.
Payback period and average rate of return
Study the information in the table below and then answer the questions that follow.
Year Net cash flow
Project Atlanta ($) Project Boston ($)

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0 140 000 (150 000)
1 80 000 60 000
2 60 000 60 000
3 20 000 60 000
(a) State the cost of the investment projects under consideration. [2 marks]
(b) Calculate the payback period for both projects and comment on your findings. [4 marks]
(c) Calculate the average rate of return on both projects. Assuming that the savings interest rate is 4.75%,
comment on your findings. [4marks]
(d) Considering all relevant factors, examine which investment project is more attractive. [6 marks]
MARKSCHEME
(a) $140 000 Award 1 mark for correctly identifying the cost of the investment projects.
(b) Project Atlanta has the shorter payback period, i.e. it reaches breaks even quicker (but only by 4 months).
Atlanta Boston
Cumulative cash flow (after 2 years) $140 000 $120 000
Payback period 2 years 2 years and 4 months
Award up to 2 marks for correctly calculating the payback periods for both projects.
Award up to 2 marks for the commentary, applying the own figure rule (error carried forward) where
applicable.

(c) Project Atlanta has an ARR of 4.76% which is only marginally higher than the savings interest rate at
4.75%, i.e. the investment risk might not be worthwhile. By contrast, Project Boston has a much better
ARR of 9.52% (more than double the savings interest rate), even though both projects cost the same
amount of money.

Award up to 2 marks for correctly calculating the average rate of return for both projects, with the working
out shown.
Award up to 2 marks for the commentary, with consideration of the benchmarked savings interest rate.

Atlanta Boston
Payback 2 years 2 years and 4 months
ARR 4.76 % 9.52%

This depends on whether the firm’s priority was a quick return on the investment (in which case Project
Atlanta would be picked) or if profit was more of a priority. Although there is a much better average rate of
return for Project Boston, a large amount of the money is received at a later stage in the project’s timeline,
i.e. it would be worth less based on today’s value.
Both projects have an expected annual return that is greater than the base interest rate, albeit very
marginally for Project Atlanta. Nevertheless, Project Boston yields a significantly higher return than Project
Atlanta, making it relatively more attractive despite its slightly longer payback period.
Award 1–2 marks for a generalized answer that lacks details of which investment project is most attractive,
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given the available information.
Award 3–4 marks for a good examination of several factors, with some understanding of which investment
project is most attractive. The answer might lack substance in some areas or the application of the stimulus
material.
Award 5–6 marks for a thorough examination of several factors, with a detailed understanding of which
investment project is most attractive based on the stimulus material. There is effective use of relevant
business management terminology.
WE TRANSFER AND SELF-EVALUATE (50 MINUTES)
Activity 03: Solve the following study case.

ASHTON TEXTILES LTD PLANS AN INVESTMENT

Ashton Textiles Ltd is planning an investment programme to overcome a problem of demand exceeding
capacity. It is considering two alternative projects involving new machinery. The initial outlays and future cash
outflows are given below. Ashton has a good relationship with the supplier of the machine for Project Y, but
has not dealt with the supplier of Project X before although this supplier has a good reputation. The machine
for Project X is imported and there are some concerns about changes in the exchange rate and how this might
affect the final cost of Project X. The machine for Project Y is supplied by a local firm. One of Ashton’s
competitors uses the machine for Project X and raises some concerns about the reliability of the machine,
although the salespeople from the machine’s supplier say it has the best reliability of any similar machine on
the market.
YEAR PROJECY X PROJECT Y
0 ($50 000) ($80 000)
1 $25 000 $45 000
2 $20 000 $35 000
3 $20 000 $17 000
4 $15 000 $15 000
5 $10 000 -

Net cash flows for Project X and Project Y

1. Define the term ‘investment appraisal’. [2 Marks]
2. Calculate the payback periods for Project X and Project Y. [4 Marks]
3. Calculate the ARR for Project X and Project Y. [4 Marks]
4. On the basis of financial and non-financial factors evaluate whether Ashton Textiles Ltd should
choose Project X or Project Y. [10 Marks]

Rubric for case study “ASHTON TEXTILES LTD PLANS AN INVESTMENT”

Competence Responsible management of financial resources

Capacity Understand the functioning of the economic and financial system

Make economic and financial decisions

Performances Evaluates investment opportunities using payback period and average rate of
return (ARR) to select investment alternatives.
Evidence Case study: ASHTON TEXTILES LTD PLANS AN INVESTMENT

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Evaluation Performance descriptors
criteria
In start In progress Expected Outstanding Score
achievement Achievement awarded
(1 point) (2 points)
(3 points) (4 points)

Understand Little knowledge Description of Little Understands

concepts, of the pertinent relevant topics understanding of concepts,
principles and topics and of the with some use of the pertinent principles, tools,
theories of tools, techniques tools, techniques topics and of the techniques,
Business and theories of and theories of tools, techniques theories and
Management in Business Business and theories of terminology of
local and global Management Management Business Business
contexts Management Management

Use of Little use of Some use of Proper use of Relevant use of

appropriate and Business Business Business Business
pertinent Management Management Management Management
Business terminology terminology terminology terminology
Management
terminology

Analyze Little application Certain tools Business Tools (when

business of tools (when (when Management applicable),
decisions and applicable), applicable), tools (when techniques and
alternative techniques and techniques and applicable), theories of
solutions theories of theories of techniques and Business
applying Business Business theories are Management are
theories, Management that Management are applied but the applied and a
techniques and do not allow a applied and an analysis is pertinent
tools of pertinent outline of superficial analysis is
Business analysis analysis is carried out
Management appreciated

Demonstrates Demonstrates Demonstrates Demonstrates Demonstrates

technical skills few technical certain technical technical skills in dexterity in
relevant to the skills in case skills in case development technical skills in
business case development developing the case
case development

Evaluate Identify the Analyze the Evaluates Evaluates

situations, strengths and strengths and business business
decisions or weaknesses of weaknesses of strategies and strategies and
alternatives some business some business practices by practices by
associated with strategies and strategies and assessing assessing
each business practices related practices related strengths and strengths and
situation to the case to the case weaknesses to weaknesses to
reveal some reveal inherent
inherent assumptions to
assumptions in the case.
the case

Total score

4. WE REFLECT ON OUR RESULTS DE APRENDIZAJE (10 MINUTES)

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Activity 04: Now reflect about your new learnings and applications.
1. What key concepts have we worked today?
2. Did you like the way you performed the work?
3. How did you feel working with the activities?
4. Which part were you best?
5. What will you do in order to improve your weaknesses?
6. Do you think that one should be principled or caring when evaluating an investment?

BIBLIOGRAPHY AND RESOURCES DE APRENDIZAJE

BIBLIOGRAPHY
‐ Organización del Bachillerato Internacional (2014). Guía de Gestión Empresarial. Primera evaluación
2016. Cardiff: IBO
‐ Hoang, P. (2013). Business Management (3rd ed.). Melton: IBID Press.
‐ Lominé, L., Muchena, M. & Pierce, R. (2014). Business Management: Course companion. Oxford: Oxford
University Press.
‐ Stimpson, P. & Smith, A. (2015). Business Management for the IB Diploma (2 nd ed.). Cambridge:
Cambridge University Press.

AUTHORSHIP
Yaranga, N. (2023). MDFL: “Investment Appraisal” – Unit 2, Session N° 07.

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