6.3b Investment

What is Investment?

Investment is money which a business spends to become more profitable

Typical Business Investments

Land and buildings

Expanding existing facilities or buying new ones

New machinery

Improving efficiency, or reducing labour costs

New vehicles

Larger, cheaper to run vehicles to transport more goods

Research & development

Bringing new products to the market

Investment Risk

The additional revenue might be less than the business invests
This will result in a loss on the investment

Example: a business spends £100k on a new machine, but revenue does not increase. This is a significant loss!

Calculating Return on Investment

A business can calculate the average rate of return (ARR) on an investment over its lifespan.
It is expressed as a percentage.
The greater the percentage, the better the investment.
A negative percentage indicates an investment is likely to return a loss!

Average Rate of Return

Investment average rates of return are calculated on the average expected profit over several years. In an exam, you may need to calculate the average profit first.

Average Rate of Return — Example

A business plans to invest £50,000 over a five-year period. It expects the additional profits per year to be…

What is the average annual profit?

Answer

What is the average rate of return?

Answer

Average Rate of Return: Pros and Cons

Advantages

Provides a clear and easy-to-understand percentage value
Easy to compare the potential returns of different investments
Considers the entire investment period, making it suitable for evaluating long-term projects

Disadvantages

Does not consider inflation
Relies on estimated average annual profits from the investment. These may not be accurate