Investment Projects aqa

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Exam code:8132

Types of investment projects

Over time, businesses need to buy or upgrade assets such as machinery, vehicles or property
- Businesses may need to buy, renovate, upgrade or extend land and buildings to house their operations
  - Examples include factories, office space, retail stores and warehouses
  - Owning the land and buildings gives them control over these spaces
- Machinery such as production lines, tools and IT equipment are used in manufacturing and administration processes
  - Initial investments in machinery, as well as upgrades, help to reduce average production costs, increase quality and maintain efficiency
Businesses also make investments in research and development activities, including:
- Market research
- Inventing new materials and processes
- Developing prototypes
- Beta testing
- Test marketing

Calculating the average rate of return

The average rate of return helps a business determine whether an investment will be worthwhile
- It compares the average profit generated each year by an investment with the cost of the investment
It is expressed as a percentage and calculated using the formula:

$Average space rate space of space return space equals space fraction numerator Average space yearly space profit over denominator Cost space of space investment end fraction space cross times 100 space space space space space space$

The higher the outcome, the greater the return on investment
- Investments with high average rates of return are more worthwhile than those with lower rates

Worked Example

Creative Frames, a small artwork framing business based in Bermuda, is considering an investment of $40,000 in new machinery. Megan, the business owner, believes that total returns over a 6-year period will be $76,000

Calculate the Average Rate of Return of the proposed investment. [4 marks]

Step 1: Deduct the cost of the investment from the total forecasted returns

$76,000 – $40,000 = $36,000 [1]

Step 2: Divide the outcome by the number of years of use to determine the average yearly profit

$36,000 ÷ 6 years = $6,000 [1]

Step 3: Substitute the values into the ARR formula

$ARR space equals space fraction numerator Average space yearly space profit over denominator Cost space of space investment end fraction space straight x space 100 equals space fraction numerator 6 comma 000 over denominator 40 comma 000 end fraction space straight x space 100 equals space 0.15$ [1]

Step 4: Multiply the outcome by 100 to find the percentage
0.15 x 100 = 15% [1]

Evaluation of average rate of return (ARR)

Advantages	Disadvantages
ARR considers all of the net cash flows generated by an investment over time ARR is easy to understand and compare the percentage returns of different investments with each other	It depends on forecasts of future profits, so may not be accurate The opportunity cost of the investment is ignored, as values are neither expressed in real terms nor adjusted for the impact of interest rates and time

Examiner Tips and Tricks

Make sure that you include all of your workings in calculation questions. The Own Figure Rule (OFR) means that even if part of your answer is incorrect, you can still receive some marks.

Business GCSE AQA