When buying stocks, you are investing cash today in expectation of future returns.
There should be a process to evaluate opportunities to see if their benefit is greater than their cost and also which stocks should recevie priority where capital is limited.
This process is known as “investment appraisal”.
The main benefits from an investment are its future net cash inflows.
Its two main costs are
- the amount of the actual investment (capital outflows) and
- the cost of financing the investment over the long term (the cost of capital).
The non-financial benefits and costs of an investment as well as its risk are also releveant considerations.
There are several ways to appraise investments:
1. Payback period
2. Annual yield
3. Measures which use discounted cash flows.
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