OxfordAQA A-Level Accounting: Capital investment appraisal (9615) – Revision Notes

These notes condense section 3.2.3 Capital investment appraisal of the OxfordAQA International AS and A-level Accounting (9615) specification, Version 1.2, for International A-level exams from May/June 2026 onwards. Section 3.2.3 is International A-level only, and the specification assesses it in Paper 4: Accounting for analysis and decision making. If a point here is unclear, the study guide explains it step by step. Money is in dollars; the firms are made up.

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The four things 3.2.3 asks of you

1. Calculate and use project cash flows.
2. Calculate payback period and net present value, and use the four listed terms (cost of capital, discount factor, payback period, net present value) correctly.
3. Explain the benefits and limitations of payback and net present value.
4. Use the measures, with financial and non-financial factors, to evaluate projects.

Key terms

Term	Meaning in one line
Capital project	Spending now on a non-current asset that brings benefits over several years
Net cash flow	Cash in minus cash out caused by the project in one year
Payback period	Time taken for net cash inflows to equal the initial outlay
Cost of capital	Return required by lenders and owners; the minimum a project must earn; the discount rate
Discount factor	Multiplier that converts a future sum into today’s value
Present value	Future cash flow × discount factor
Net present value	Total of all present values, outlay negative
Residual value	Cash from selling the asset at the end of its life

Formulas

What	How
Payback, equal annual inflows	Initial outlay ÷ annual net cash inflow
Payback, unequal inflows	Full years before recovery + (amount unrecovered at start of the year ÷ that year’s net cash flow)
Converting a fraction of a year	Fraction × 12 = months
Discount factor	1 ÷ (1 + r)ⁿ, r as a decimal, n = year
Year-0 discount factor	1.000
Present value	Cash flow × discount factor
Net present value	Sum of present values of inflows − initial outlay

What goes in the cash flow schedule

In	Out
Purchase price, delivery and installation (year 0)	Depreciation (not a cash flow)
Sale of a replaced asset (reduces year-0 outlay)	Sunk costs (already spent)
Extra receipts or cash savings	Shared fixed overheads that do not change
Extra running payments	Interest on finance (the cost of capital covers it)
Residual value (final year)	Anything that happens whether or not the project goes ahead

Conventions. Year 0 is now. For NPV, later cash is treated as arriving at each year end. For payback, cash is treated as arriving evenly through the year.

Method in steps

Payback

1. Put the outlay in year 0 as a negative.
2. List each year’s net cash flow.
3. Keep a cumulative total.
4. Find the first year in which the cumulative total reaches zero or above.
5. Fraction = amount still owed at the start of that year ÷ that year’s net cash flow.
6. Convert the fraction to months and state “x years y months”.

Net present value

1. Set out four columns: year, net cash flow, discount factor, present value.
2. Year 0 factor is 1.000; use given factors for later years, or calculate them.
3. Multiply across each row.
4. Add the residual value into the final year’s cash flow before discounting.
5. Total the present value column.
6. Say what the sign means for the decision.

Worked reminder: Lintmoor Café

Lintmoor Café plans a 20,000 coffee bar, with net inflows of 9,000, 9,000 and 7,000 over three years. Cost of capital 5%.

Year  Cash flow   Factor 5%   Present value   Cumulative
0     (20,000)    1.000       (20,000)        (20,000)
1      9,000      0.952         8,568         (11,000)
2      9,000      0.907         8,163          (2,000)
3      7,000      0.864         6,048           5,000
                  NPV            2,779

• Payback: 2 years + (2,000 ÷ 7,000) × 12 = 3.4 months, so 2 years 3 months to the nearest month.
• NPV 2,779 positive: the coffee bar earns more than 5%, so it is acceptable on financial grounds.

Worked reminder: equal inflows plus a residual value

A 45,000 kiln brings in a net 13,500 a year for four years and is sold for 5,000 at the end of year 4. Cost of capital 9%.

• Payback uses the equal-inflow formula: 45,000 ÷ 13,500 = 3⅓ years; ⅓ × 12 = 4 months, so 3 years 4 months. The 5,000 sale is not needed, because the outlay is recovered first.
• NPV: year 4 cash flow = 13,500 + 5,000 = 18,500.

Year  Cash flow   Factor 9%   Present value
1     13,500      0.917       12,380
2     13,500      0.842       11,367
3     13,500      0.772       10,422
4     18,500      0.708       13,098
      PV of inflows           47,267
      less outlay            (45,000)
      NPV                      2,267

Present values are rounded to the nearest dollar.

Benefits and limitations at a glance

	Payback	NPV
For	Simple and quick; easy for non-specialists	Allows for the time value of money
For	Stresses early, more reliable years	Uses all cash flows, including residual value
For	Protects liquidity; useful in fast-changing markets	Linked to the return lenders and owners need
For		Shows value added in money terms, so projects can be ranked
Against	Ignores the time value of money	Harder to calculate and explain
Against	Ignores cash after the payback point	Result depends on the cost of capital chosen
Against	Does not measure value added	Relies on long-range forecasts
Against	Cut-off period is a matter of judgement	Says nothing about speed of recovery

Evaluating a project: points to pick from

Financial

• Sign and size of the NPV; length of payback against any target.
• Sensitivity: what happens if inflows fall or costs rise?
• Availability and cost of finance; effect on liquidity.
• Opportunity cost: other uses of the same funds.

Non-financial

• Staff: jobs, training, morale.
• Customers: quality, reliability, reputation.
• Suppliers: dependability, after-sales service, spare parts.
• Environment, legal and safety requirements.
• Fit with the owners’ long-term aims.

Finish with a clear recommendation that refers back to at least one figure.

Must-know distinctions

• Profit vs cash flow. Profit includes depreciation and accruals; appraisal uses cash only.
• Payback vs NPV. Payback measures speed of recovery; NPV measures value added after allowing for timing.
• Cost of capital vs discount factor. The cost of capital is a percentage; the discount factor is the multiplier calculated from it for a particular year.
• Sunk vs relevant. A cost already paid cannot change the decision; only future, extra cash counts.
• Undiscounted vs discounted totals. Inflows can exceed the outlay before discounting and still give a negative NPV.

Quick self-test

1. A 33,000 machine adds a net 12,000 to cash each year. How long is its payback period?
2. Calculate the year-1 discount factor at a 12% cost of capital, to three decimal places.
3. Calculate the present value of 20,000 received at the end of year 3 if the discount factor is 0.840.
4. The cumulative cash flow is (9,000) at the end of year 2 and year 3’s net inflow is 27,000. State the payback period.
5. A forecast includes depreciation of 5,000 a year. How is it treated in an NPV calculation?
6. The inflows of a 90,000 project have a total present value of 84,300. Calculate the NPV and give the decision.
7. A business paid 4,000 for market research last year. Is it relevant to the appraisal?
8. Which of the two methods allows for the time value of money?
9. What is the discount factor for year 0?
10. A new oven costs 40,000 and the old oven is sold now for 3,000. What is the year-0 net cash flow?

Answers

1. 33,000 ÷ 12,000 = 2.75; 0.75 of a year is 9 months, giving 2 years 9 months.
2. 1 ÷ 1.12 = 0.893.
3. 20,000 × 0.840 = 16,800.
4. 9,000 ÷ 27,000 × 12 = 4 months, so 2 years 4 months.
5. Leave it out: depreciation is not a cash flow.
6. 84,300 − 90,000 = (5,700); negative, so reject on financial grounds.
7. No: it is a sunk cost.
8. Net present value.
9. 1.000.
10. 40,000 − 3,000 = (37,000).

Where marks are usually lost

• Counting depreciation as a payment, or forgetting that the sale of a replaced asset reduces the outlay.
• Treating 0.4 of a year as 4 months; multiply by 12 first.
• Using the cumulative figure as the divisor for the part-year.
• Leaving the residual value out of the final year of the NPV table.
• Discounting the year-0 outlay at a factor other than 1.000.
• Stating “accept” without saying the NPV is positive, or accepting a negative NPV project because it pays back.
• Defining cost of capital as “the cost of the machine”.
• Listing generic advantages that never mention the firm in the case.
• Writing an evaluation with no final recommendation.

Official syllabus

OxfordAQA International AS and A-level Accounting (9615) specification, Version 1.2, for International AS exams May/June 2025 onwards and International A-level exams May/June 2026 onwards (OxfordAQA). Section 3.2.3 Capital investment appraisal.