Key Idea: In 3.8, IB wants you to compare investment options using payback and ARR, then justify a recommendation using both numbers and business context.
⏱️ Payback: **Payback period —** time to recover initial investment. **Focus —** speed and risk. **Shorter payback —** preferred. **Best for —** cash-sensitive businesses.
📊 ARR: **ARR —** average annual profit ÷ investment × 100. **Focus —** profitability. **Higher ARR —** preferred. **Best for —** long-term return.
Core formulas and facts (memorise)
- Payback (even flows) — cost ÷ annual cash inflow
- Payback (uneven) — use cumulative method
- ARR — (average annual profit ÷ investment) × 100
- Average profit — total profit ÷ years
- Total profit — total inflows − initial cost
🤔 Trade-offs: **Short payback, low ARR —** safer but less profitable. **Long payback, high ARR —** more profitable but riskier. **Start-ups —** prefer payback. **Stable firms —** may prefer ARR.
⚠️ Limitations: **Payback —** ignores profits after payback. **ARR —** ignores timing of cash flows. **Both —** ignore uncertainty. **Best answers —** include qualitative factors.
High-yield facts examiners expect
- Payback focuses on risk and liquidity
- ARR focuses on profitability
- Use both methods together
- Consider qualitative factors: risk, strategy, market conditions
- Different businesses may choose differently
- Recommendations must be justified
Always show full working in calculations.
Use cumulative cash flow for uneven payback calculations.
Do not forget to subtract initial investment when calculating ARR.
Always justify recommendations using both data and reasoning.
Example: A strong answer: Project A has a shorter payback so is less risky, while Project B has a higher ARR so is more profitable. The best choice depends on whether the business prioritises cash flow or long-term return.
Important: Common triggers: calculate payback, calculate ARR, compare options, evaluate methods, recommend an investment.
- Calculate with full working
- State results clearly
- Compare options
- Include qualitative factors
- Make a justified recommendation