qualitative factors and their impact on investment decisions

Resources → Subject Notes → Business → Lesson Plan

10.3 Investment Appraisal – Investment Appraisal Decisions

1. Aim of this Section

To equip you with the knowledge and skills required by the Cambridge IGCSE/A‑Level (9609) syllabus to:

  • Define investment appraisal and explain why it is carried out.
  • Apply the three quantitative techniques required for the exam – Pay‑back period, Accounting Rate of Return (ARR) and Net Present Value (NPV).
  • Identify the key qualitative (non‑financial) factors that influence a decision.
  • Use a simple weighted scoring matrix to assess qualitative factors.
  • Combine quantitative results and qualitative scores to reach a balanced recommendation.

2. What is Investment Appraisal?

Definition: A systematic evaluation of a proposed capital project to decide whether it will add value to the business and support its strategic objectives.

Purpose (exam‑relevant points):

  • Allocate scarce capital to the most rewarding projects.
  • Provide a basis for comparing alternative projects.
  • Identify and manage risk and uncertainty before resources are committed.
  • Communicate a clear, defensible decision to stakeholders.

3. Quantitative Techniques (required by the syllabus)

These methods give a numerical indication of a project’s profitability.

Technique Key Formula / How to calculate When it is most useful (exam tip)
Pay‑back Period \[ \text{Pay‑back} = \frac{\text{Initial investment}}{\text{Average annual cash inflow}} \] Quick check of liquidity and short‑term risk; easy to calculate in the exam.
Accounting Rate of Return (ARR) \[ \text{ARR} = \frac{\text{Average annual accounting profit}}{\text{Initial investment}}\times 100\% \] Compares profitability with a required accounting return; uses profit rather than cash flow.
Net Present Value (NPV) \[ \text{NPV}= \sum_{t=0}^{n}\frac{C_t}{(1+r)^t} \] where \(C_t\) = net cash flow in year \(t\) and \(r\) = discount rate (cost of capital). Measures value added after accounting for the time value of money; the primary “accept‑if‑positive” test.

Optional A‑Level extension – Internal Rate of Return (IRR): The discount rate that makes NPV = 0. Useful for deeper analysis but not required for the IGCSE.

Pros and Cons (exam‑friendly summary)

Technique Advantages Disadvantages
Pay‑back Simple; highlights cash‑flow risk. Ignores cash flows after the pay‑back year and the time value of money.
ARR Uses readily available accounting data; easy to explain. Based on profit, not cash flow; does not consider discounting.
NPV Considers all cash flows and the cost of capital; gives a clear “add‑value” decision. Requires an estimate of the discount rate and reliable cash‑flow forecasts.

4. Qualitative (Non‑Financial) Factors

These are the “soft” considerations that can tip the balance when the numbers alone are inconclusive.

Factor What to assess (exam prompts) Typical impact on the decision
Strategic Fit Does the project support the 3‑year plan or core competencies? High fit may justify a lower NPV threshold or a higher discount rate.
Brand & Reputation Effect on brand‑equity, customer perception, media coverage. Negative impact can lead to rejection even with a positive NPV.
Employee Morale & Skills Development Training needs, turnover risk, staff engagement. Improved morale may offset modest financial returns.
Environmental & Sustainability Carbon emissions, waste reduction, eligibility for green finance. Positive outcomes can attract subsidies or lower borrowing costs.
Legal & Regulatory Compliance Potential fines, licensing, future legislation. High risk raises the discount rate or may cause outright rejection.
Social Responsibility & Community Relations Local job creation, community support, CSR objectives. Strong CSR can improve goodwill and market access.
Market & Competitive Dynamics Competitor actions, market‑share forecasts, consumer trends. Favourable dynamics may justify a larger investment.
Technological Change Obsolescence risk, need for future upgrades, system compatibility. Rapid change increases uncertainty – often requires scenario analysis.
Political / Legislative Stability Stability of government policy, tax changes, trade restrictions. Unstable environments raise perceived risk → higher discount rate.
Stakeholder Expectations (beyond CSR) Shareholder pressure, supplier relationships, customer activism. Failure to meet expectations can damage future projects.
Overall Risk & Uncertainty Combined effect of the above that is not captured numerically. May lead to conditional approval or further sensitivity testing.

Why a systematic approach?

  • Reduces subjectivity – each factor is judged against the same criteria.
  • Provides a transparent record for examiners (they look for a clear rationale).
  • Allows easy comparison of alternative projects.

5. Simple Weighted Scoring Matrix (exam‑friendly)

Step‑by‑step:

  1. List the relevant qualitative factors for the project.
  2. Assign a weight (w) to each factor – the total of all weights must equal 1.00.
  3. Score each factor on a 1–5 scale (1 = very poor, 5 = excellent).
  4. Calculate the weighted score: w × score.
  5. Sum the weighted scores – this is the project’s qualitative rating.
Factor Assessment criterion (example) Score (1‑5) Weight (w) Weighted score (w × s)
Strategic Fit Direct contribution to 3‑year plan 4 0.15 0.60
Brand Impact Change in brand‑equity index 2 0.10 0.20
Employee Morale Training cost vs retention benefit 3 0.08 0.24
Environmental Impact CO₂ reduction (tonnes) / compliance cost 5 0.12 0.60
Legal Compliance Regulatory risk rating (low‑high) 2 0.10 0.20
Social Responsibility Community support score 4 0.08 0.32
Market Dynamics Projected market‑share gain 3 0.10 0.30
Technological Change Obsolescence risk (low‑high) 3 0.07 0.21
Political/Legislative Stability Stability index (0‑10) 4 0.10 0.40
Stakeholder Expectations Alignment with major stakeholder demands 3 0.10 0.30
Total weighted score 3.77

Interpretation tip for the exam: Set a pre‑determined threshold (e.g., 3.5). If the total exceeds the threshold, the qualitative side is “acceptable”.

6. Integrating Quantitative and Qualitative Appraisal

The Cambridge syllabus expects you to present **both** dimensions in the final recommendation.

  1. Quantitative analysis – calculate Pay‑back, ARR and NPV. Compare each result with the firm’s stated criteria (e.g., Pay‑back ≤ 4 years, ARR ≥ 12 %, NPV > 0).
  2. Qualitative scoring – use the weighted matrix to obtain a total score.
  3. Decision rule – combine the two outcomes:
    • Go – quantitative criteria met **and** qualitative score ≥ threshold.
    • Conditional Go – quantitative OK but qualitative score below threshold; proceed only if specific conditions are satisfied (e.g., obtain environmental certification).
    • No‑Go – either side fails to meet its standard.

Two‑column decision matrix (exam illustration)

Quantitative Result Qualitative Score
  • Pay‑back: 3.2 years (target ≤ 4 years) – Pass
  • ARR: 14 % (target ≥ 12 %) – Pass
  • NPV: £0.6 m (target > 0) – Pass
  • Total weighted score = 4.61 (threshold 4.0) – Pass
Final recommendation – Go

7. Worked Example (Cambridge‑style)

Company: GreenTech Ltd., manufacturer of solar panels.

Proposed investment: New automated assembly line – £4 million.

Step 1 – Quantitative calculations

MetricResultCompany criterionResult?
Pay‑back period3.2 years≤ 4 yearsPass
ARR14 %≥ 12 %Pass
NPV (10 % discount)£0.6 million> 0Pass

Step 2 – Qualitative scoring (weights sum to 1.00)

FactorScore (1‑5)WeightWeighted score
Strategic Fit – expansion into high‑growth market50.201.00
Brand Impact – enhances green image40.100.40
Employee Morale – up‑skilling opportunities30.080.24
Environmental Impact – waste ↓ 30 %50.150.75
Legal Compliance – meets new EU standards50.070.35
Social Responsibility – creates local jobs40.080.32
Market Dynamics – rising solar demand40.120.48
Technological Change – future‑proof equipment40.070.28
Political Stability – stable subsidies30.080.24
Stakeholder Expectations – ESG‑focused shareholders50.050.25
Total weighted score 4.61

Step 3 – Decision

  • Quantitative criteria: All satisfied.
  • Qualitative threshold (set at 4.0): 4.61 > 4.0 → satisfied.
  • Recommendation: Go – GreenTech should proceed with the automated line.

8. Summary Checklist (useful for revision)

  • Define investment appraisal and list its four main purposes.
  • Know how to calculate Pay‑back, ARR and NPV; remember the exam‑friendly formulas.
  • State one advantage and one disadvantage for each quantitative technique.
  • Identify at least eight qualitative factors; be ready to discuss their impact.
  • Be able to construct a weighted scoring matrix (weights must total 1.00).
  • Explain how to combine the quantitative “pass/fail” test with the qualitative score to reach a final “Go / Conditional Go / No‑Go” decision.
  • Remember the optional IRR is an A‑Level extension – do not include it unless asked.

9. Quick Reference – Key Formulas

MetricFormula
Pay‑back period\(\displaystyle \text{Pay‑back} = \frac{\text{Initial outlay}}{\text{Average annual cash inflow}}\)
ARR\(\displaystyle \text{ARR} = \frac{\text{Average annual profit}}{\text{Initial investment}}\times100\%\)
NPV\(\displaystyle \text{NPV}= \sum_{t=0}^{n}\frac{C_t}{(1+r)^t}\)
Weighted qualitative score\(\displaystyle \text{Total} = \sum (w_i \times s_i)\)

With these tools you can meet every requirement of the Cambridge 9609 syllabus for Topic 10.3 and produce a clear, balanced investment‑appraisal recommendation.

Create an account or Login to take a Quiz

30 views
0 improvement suggestions

Log in to suggest improvements to this note.