Investment Appraisal Techniques Definition
There are a number of different investment appraisal techniques that can be used in order to assess whether or not an investment is likely to be successful. The most common of these techniques are net present value (NPV), internal rate of return (IRR), and payback period.
NPV is a technique that takes into account the time value of money in order to assess an investment’s potential profitability. In essence, NPV calculates the difference between the present value of the cash inflows from an investment and the present value of the cash outflows. If the NPV is positive, then the investment is considered to be viable; if it is negative, then the investment is not considered to be viable.
IRR is another technique that takes into account the time value of money. However, rather than simply calculating the difference between present values, IRR actually calculates the interest rate that would make the NPV of an investment equal to zero. In other words, it tells you what ‘hurdle rate’ an investment must meet in order for it to be considered profitable.
Payback period is a much simpler technique that does not take into account the time value of money. It simply looks at how long it will take for an investment to ‘pay back’ its initial cost. Obviously, shorter payback periods are preferable to longer ones.
Each of these techniques has its own strengths and weaknesses, and which one you use will depend on your specific situation
