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

This guide teaches 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, assessed in Paper 4: Accounting for analysis and decision making. The businesses and numbers are made up, and all money is in dollars.

Use it with the revision notes and the practice questions. The idea of a relevant, future cost also runs through marginal costing, and a project’s receipts and payments often feed a cash budget. See also exam preparation. Links: course hub · printable checklist · free 10-minute diagnostic.

What 3.2.3 covers

Specification statement (International A-level only)	Your skills
The calculation and use of cash flows in capital investment appraisal	Build a year-by-year net cash flow schedule from the information given
Payback and net present value (discounted cash flow) of a capital project	Work out both measures; explain each term the specification lists
The benefits and limitations of the payback and net present value methods of capital investment appraisal	Weigh up each method
The use of capital appraisal measures in the evaluation of projects	Reach a judgement using financial and non-financial factors

Only two methods appear in the specification.

Why capital projects need their own appraisal

A capital project commits a large sum now to a non-current asset, such as a vehicle or a production line, for benefits spread over several years. Appraisal asks two questions first: how quickly does the cash come back, and is the project worth more than it costs once timing is allowed for?

1. Cash flows for appraisal

Appraisal works with cash, not profit. The test for every item is simple: will this cash move in the future and only because the project goes ahead? If yes, include it. If no, leave it out.

Usually included

• The purchase price of the asset, plus any delivery, installation or set-up cost.
• Cash from selling an old asset that the new one replaces. This reduces the year-0 outlay.
• Extra cash receipts from customers, or cash savings such as lower energy bills.
• Extra running payments: staff, materials, power, servicing, insurance.
• The cash expected from selling the asset at the end of its life (its residual value).

Always excluded

• Depreciation. No cash leaves the business when it is charged. The cash cost of the asset is already counted when it is bought.
• Sunk costs, which have already been paid and cannot be recovered whatever is decided.
• Fixed overheads shared out to the project that will be paid at the same level anyway.
• Interest on money borrowed to fund the project. The cost of capital used for discounting already allows for the cost of finance, so counting interest as well would charge for it twice.

Timing conventions. “Year 0” means today. In net present value work, each later year’s cash is treated as arriving on the last day of that year. In payback work, cash is treated as arriving evenly across each year, which is what lets you express part of a year in months.

Worked example 1: Wexcombe Cider’s cash flows

Wexcombe Cider, which supplies cider to local pubs, is thinking of buying a canning line for 210,000, with 14,000 of installation work, both paid now. Its two old bottle fillers would be sold today for 8,000. The canning line would last five years and then be sold for 18,000. The manager has also supplied these items:

• depreciation of 41,200 a year on the straight-line basis;
• a 2,400 fee paid last month to an engineer who checked the floor could take the weight;
• 6,000 a year of existing head-office costs to be charged to the canning line;
• interest of 9,000 a year on a bank loan that would fund the purchase.

None of these four items belongs in the appraisal.

Year 0: 210,000 + 14,000 − 8,000 = (216,000). Brackets mean cash out.

Year	Extra receipts	Extra payments	Sale of line	Net cash flow
1	118,000	68,000		50,000
2	134,000	75,000		59,000
3	149,000	81,000		68,000
4	150,000	85,000		65,000
5	140,000	86,000	18,000	72,000

2. Payback period

The payback period is the length of time a project’s net cash inflows take to equal its initial outlay. A business often sets a maximum it will accept, and a shorter payback is treated as safer.

• If the inflow is the same every year: payback = initial outlay ÷ annual net cash inflow.
• If inflows differ: keep a running (cumulative) total and find the year in which it stops being negative. The fraction of that year is the amount still unrecovered at its start divided by that year’s net cash flow. Multiply by 12 for months.

Worked example 2: Wexcombe’s payback

Year	Net cash flow	Cumulative
0	(216,000)	(216,000)
1	50,000	(166,000)
2	59,000	(107,000)
3	68,000	(39,000)
4	65,000	26,000

After three years, 39,000 is still to recover. Year 4 brings 65,000.

39,000 ÷ 65,000 = 0.6 of a year; 0.6 × 12 = 7.2 months. Payback is 3 years 7 months to the nearest month. Year 5 is not needed.

3. Net present value

Money due in future is worth less than the same sum today: cash in hand can earn a return, inflation erodes later cash, and a promised receipt might never arrive. Net present value converts every future cash flow into today’s money.

Terms you must use correctly

• Cost of capital: the percentage return that the providers of finance (lenders and owners) require. It is the lowest return a project can earn and still be acceptable, and it is the rate used for discounting.
• Discount factor: converts cash due in a later year into today’s money. For a cost of capital r, written as a decimal, and cash at the end of year n, the factor is 1 ÷ (1 + r)ⁿ. Year 0 always has a factor of 1. Where a question supplies discount factors, use those figures unchanged; this page rounds factors to three decimal places.
• Present value: what a future sum is worth now, found as the cash flow times its discount factor.
• Net present value (NPV): the sum of the present values of all the project’s cash flows, with the outlay negative.

Decision rule. A positive NPV means the project returns more than the cost of capital, so accept it on financial grounds. A negative NPV means it returns less, so reject it on financial grounds. Between projects competing for the same funds, the higher positive NPV is preferred on financial grounds.

Worked example 3: Wexcombe’s NPV at a 14% cost of capital

Year	Net cash flow	Discount factor at 14%	Present value
0	(216,000)	1.000	(216,000)
1	50,000	0.877	43,850
2	59,000	0.769	45,371
3	68,000	0.675	45,900
4	65,000	0.592	38,480
5	72,000	0.519	37,368
		NPV	(5,031)

The present values of the inflows total 210,969, which is 5,031 short of the outlay. Undiscounted, the canning line returns 314,000 for 216,000 and pays back inside its life, yet it earns less than 14% a year. On financial grounds Wexcombe should not buy it at this cost of capital. This is the gap that NPV exposes and payback cannot.

4. Benefits and limitations of each method

Payback: benefits

• Quick to work out and easy to explain to non-accountants.
• Concentrates on the early years, where forecasts are least likely to be wrong.
• Helps a business that is short of cash, because it favours projects that return cash soon.

Payback: limitations

• Ignores the time value of money: a dollar in year 3 counts the same as a dollar in year 1.
• Ignores everything after the payback point, including a large residual value.
• Gives no measure of how much value a project creates.
• The maximum acceptable payback period is a matter of opinion.

NPV: benefits

• Discounts every cash flow, so timing is properly reflected.
• Uses the whole life of the project, including the residual value.
• Links the decision to the return that lenders and owners require.
• States in money terms how much a project adds, so projects can be ranked.

NPV: limitations

• Harder to calculate and to explain.
• The answer depends on the cost of capital chosen, and this rate is difficult to pin down.
• Assumes the forecast cash flows are accurate, although later years are the most uncertain.
• Does not tell you how fast the outlay comes back.

Neither method is better than its forecasts.

5. Using the measures to evaluate projects

Financial factors to raise: the NPV and payback results; how sensitive the result is to a fall in forecast inflows; whether finance is available and at what cost; the effect on cash and liquidity while the outlay is recovered; and what else the same funds could do.

Non-financial factors to raise: effects on employees (jobs, training, morale); quality and customer reaction; reliability of the supplier and after-sales service; environmental impact and reputation; legal or safety requirements; and fit with the owners’ long-term plans.

Worked example 4: Pellingford Lodge chooses one project

Pellingford Lodge, a country hotel, can fund only one project. Its cost of capital is 7%.

Year	Room refurbishment P	Conference suite Q	Factor at 7%
0	(96,000)	(150,000)	1.000
1	38,000	20,000	0.935
2	36,000	34,000	0.873
3	32,000	48,000	0.816
4	24,000	64,000	0.763
5	18,000	66,000	0.713

Payback. P: cumulative (58,000), (22,000), then positive in year 3. 2 years + (22,000 ÷ 32,000) × 12 = 8.25 months, so 2 years 8 months. Q: cumulative (130,000), (96,000), (48,000), then positive in year 4. 3 years + (48,000 ÷ 64,000) × 12 = 3 years 9 months.

NPV. P: 35,530 + 31,428 + 26,112 + 18,312 + 12,834 = 124,216; NPV = 28,216. Q: 18,700 + 29,682 + 39,168 + 48,832 + 47,058 = 183,440; NPV = 33,440.

Evaluation. Both projects beat the 7% cost of capital. Q adds 5,224 more value, so NPV alone points to Q. However, Q needs 54,000 more funding and takes 13 months longer to pay back. Its value depends on years 4 and 5. If those inflows were 20% lower, Q’s NPV would drop to 14,262, while the same cut would leave P at 21,987. A hotel with modest cash reserves, or doubts about demand for meeting space, would lean towards P. Non-financial points: refurbished rooms lift guest reviews at once; a conference suite brings business customers but needs extra staff. A sound recommendation here is P, unless Pellingford has firm advance bookings that make Q’s later inflows reliable.

Common errors

• Putting the old asset’s sale proceeds in year 1 instead of reducing the year-0 outlay.
• Treating loan interest as a project outflow and then discounting at the cost of capital as well.
• Leaving the residual value out of the final year of the NPV table.
• Writing 0.6 of a year as “6 months” instead of 7.2 months, or dividing by the cumulative figure instead of that year’s net cash flow.
• Multiplying the year-0 outlay by a discount factor other than 1.
• Calling a project acceptable because undiscounted inflows exceed the outlay, as Wexcombe shows.
• Ending an evaluation without a decision.

Next steps

Work through the practice questions, then condense with the revision notes. Check your wider readiness with a free diagnostic.

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.