IBDP Business Management HL: Advanced Analysis

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Investment Appraisal: Discounted Cash Flow (DCF) Logic

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DCF adjusts future cash flows to present value using a discount rate (cost of capital) to account for the time value of money (money available now is worth more than the same amount in the future). Formula: PV = Future Cash Flow / (1 + r)^n. A positive Net Present Value (NPV) indicates the project adds value and should be accepted.

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Internal Rate of Return (IRR) vs. NPV Decision Making

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While NPV calculates the absolute value added in currency, IRR calculates the percentage return expected from a project. A project is accepted if IRR > Cost of Capital (hurdle rate). IRR can be misleading for mutually exclusive projects because it ignores the scale of investment, whereas NPV maximizes shareholder wealth.

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Qualitative Factors in Investment Decisions

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Investment appraisal is not purely quantitative. Managers must evaluate non-financial factors that impact long-term viability. Examples: impact on employee morale (if automation replaces jobs), alignment with corporate mission/ethics, reputational risk, environmental impact (ESG), and strategic fit even if the NPV is marginal.

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Payback Period: Strengths and Weaknesses

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Payback calculates the time taken to recover the initial investment. Strength: useful for cash-strapped businesses and high-risk markets where quick recovery is essential. Weakness: ignores all cash flows after the payback point (profitability) and ignores the time value of money, making it less accurate than NPV for long-term projects.

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Variance Analysis: Adverse vs. Favorable Variances

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Variance analysis compares budgeted performance with actual performance. A Variance = Actual - Budgeted. Adverse (A): Profits are lower than expected (e.g., higher costs or lower revenue). Favorable (F): Profits are higher than expected (e.g., lower costs or higher revenue). Investigating 'why' helps managers correct future strategies.