# Investment appraisal techniques

*Payback, net present value and internal rate of return, and when each one misleads.*

## Production summary

- Modules to record: 1
- Total script: 343 words, about 2 minutes of finished audio
- Voices: Amara (host) and Nadia (practice educator)
- Level: Level 4, managers and decision makers

## Accreditation wording that must appear in the description

- **The CPD Certification Service** (planned): Application scheduled.

> Do not upgrade any of these words in a description or a thumbnail. Aligned is not accredited, and planned is not approved.


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## Payback, net present value and the sunk cost trap

**Runtime** about 2 minutes. **Words** 343. **Starts at** 00:00 in the full course recording.

### Learning outcomes to state on camera

- Calculate a payback period and state its weakness
- Discount future cash flows and calculate net present value
- Interpret an internal rate of return
- Identify and exclude sunk costs

### Script


`[CUE 1]` *Two projects with identical payback and very different lifetime returns.*

**AMARA**  [00:00]
Payback period. Everyone uses it. What is wrong with it?

**NADIA**  [00:04]
Nothing is wrong with it as a first filter, and it survives because everybody in the room understands it instantly, which matters more than people admit. But it is blind in two directions.

**AMARA**  [00:17]
Go on.


`[CUE 2]` *Discounting a future cash flow back to present value, year by year.*

**NADIA**  [00:18]
It ignores everything after the payback point. A project paying back in three years then earning nothing beats a project paying back in four then earning for fifteen. And it treats a pound in year four as identical to a pound today.

**AMARA**  [00:34]
Which it is not.

**NADIA**  [00:36]
Which it is not, for three reasons. Today's pound could be earning in the meantime. Inflation eats what the later one buys. And the later one might never turn up at all.


`[CUE 3]` *Net present value calculation laid out as a table.*

**AMARA**  [00:49]
So net present value fixes that.

**NADIA**  [00:51]
It does, by discounting every future amount back into today's money so you can add them up honestly. Positive net present value means the project beats your required return. When two techniques disagree, trust this one.

**AMARA**  [01:06]
Where is the catch?


`[CUE 4]` *The same project at two defensible discount rates, giving opposite answers.*

**NADIA**  [01:07]
The discount rate. It carries the entire answer, and it is chosen by a person. I can take one project and make it obviously worthwhile or obviously not, using two rates that are both defensible.

**AMARA**  [01:21]
So how do I protect against that?

**NADIA**  [01:24]
State the rate openly, and test the decision at a higher one. If the answer flips the moment you are slightly more cautious, the project is marginal and everybody should know that before signing.


`[CUE 5]` *Sunk cost crossed out of an appraisal, future cash flows circled.*

**AMARA**  [01:37]
Last one, and this is the meeting I always lose. We have spent two hundred thousand pounds already.

**NADIA**  [01:45]
Then that two hundred thousand is irrelevant. It is gone whatever you decide today. The only question is whether the future cash from continuing beats the future cash from stopping.

**AMARA**  [01:57]
It never feels irrelevant.

**NADIA**  [01:58]
It never does, because stopping feels like admitting the first decision was wrong, and the person who made it is usually sitting at the table. That discomfort is not free. It is paid for with every further pound put into something that should already have ended.

### Sources for the on screen credit

- Investment appraisal guidance, Chartered Institute of Management Accountants
- The Green Book: appraisal and evaluation in central government, HM Treasury
- Corporate finance principles, Association of Corporate Treasurers

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