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3.8 Investment appraisal

3.8 Investment appraisal (some HL only)

Learning outcomes

"An investment in knowledge pays the best interest".
Benjamin Franklin (1706 - 1790), one of the Founding Fathers of the USA

Investment refers to the capital expenditure of a business (i.e. the purchase of fixed assets or a business venture) with the intention of a financial return on the investment in the future.

The essential questions that managers need to ask regarding any investment are:

  1. What are the financial costs of the investment?
  2. How long will it take to pay for the investment and for the investment to start earning a profit?
  3. What are the opportunity costs of this investment?

Investment appraisal is the formal process of quantifying the financial risks of an investment decision. It helps to determine if a capital investment project is worthwhile, by examining the costs of the investment and the expected return on investment. Hence, investment appraisal enables decision makers to make a more informed decision, based on quantitative methods. Whilst qualitative factors may also be considered in decision-making, these are rather subjective in nature.

Businesses do not always get their investment decisions right - which is why investment appraisal can be an important decision making tool for managers. Have a look at some of these examples:

  • Along with Steve Wozniak and Steve Jobs, Ronald Wayne co-founded Apple. Ronald Wayne sold his shares for only $800 after just 12 days with the company. He had a 10 per cent stake in the company, which would be worth over $200 billion today (with Apple‘s valuation being around $2 trillion). This would make Wayne one of the top 5 richest people on the planet.

  • In 1999, a web portal company called Excite passed on the offer to buy Google for $1 million. According to Forbes, Google has a market valuation of around $1 trillion.

  • Blockbuster refused a partnership proposal made by Netflix back in 2000. Blockbuster went bankrupt in 2011. At the start of 2021, Netflix had more than 200 million paid subscribers. The company had sales revenues in excess of $25 billion in 2020 - the equivalent of more than $68.49 million per day or in excess of $2.85 million per hour(!)

The learning outcomes (or assessment objectives) for this section of the IB Business Management syllabus are:

  • Investment opportunities using payback period (AO3 & AO4)
  • Investment opportunities using average rate of return (ARR) (AO3 and AO4)
  • Investment opportunities using net present value (HL Only) (AO3 and AO4)
Top tip!

“You may prove anything by figures” - Thomas Carlyle, Scottish writer (1795 - 1881)

Many students try to include aspects of investment appraisal in their Internal Assessment (mainly the HL IA, but not uncommon for the SL IA). As with all business management tools, theories and techniques, investment appraisal (if used) must be relevant to the research question and add value to the IA.

In addition, the investment appraisal techniques in the syllabus (the payback period, average rate of return, and net present value) are best applied to the purchasing decision of a fixed asset, rather than for a complete projects which could include both fixed and non-fixed assets. In other words, investment appraisal in the IA works better for decisions about capital expenditure rather than revenue expenditure.

Above all, if you use quantitative analysis in your IA, make sure the information is meaningful and adds value to the research question.

InThinking Business Management resources

Click the hyperlinks below to access the InThinking resources for this particular section of the IB Business Management syllabus.

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