Investment Decisions (OCR GCSE Business)

Types of Investment Decisions

• Over time, businesses need to buy or upgrade assets such as machinery, vehicles or property

• Businesses may need to buy, renovate, upgrade or extend land and buildings to house their operations

  • Examples include factories, office space, retail stores and warehouses

  • Owning the land and buildings gives them control over these spaces

  • Machinery such as production lines, tools and IT equipment are used in manufacturing and administration processes

    • Initial investments in machinery, as well as upgrades, help to reduce average production costs, increase quality and maintain efficiency

• Businesses also make investments in research and development activities, including:

  • Market research

  • Inventing new materials and processes

  • Developing prototypes

• In some cases, a business may want to keep retained profit for future use by placing it in a savings account, and expect it to gain value

Average Rate of Return (ARR)

• The Average Rate of Return helps a business judge whether an investment will be worthwhile

  • It compares the initial cost of an investment with the average profit likely to be generated each year

• The ARR is expressed as a percentage and calculated using the formula:

Interpreting ARR

• The higher the outcome of the ARR formula, the greater the return on investment

  • Investments with high average rates of return are more worthwhile than those with lower rates

• The ARR can be compared with other investments, such as savings

  • E.g. A risky project may not be considered worthwhile if its ARR is only a little higher than the percentage interest rate awarded for savings in a bank

An Evaluation of Average Rate of Return (ARR)