Topic 6 - Investment Appraisal

Question 1

Capital investment

Answer 1

The investment of capital in non-current assets to help businesses generate profits

Question 2

Advantages of payback

Answer 2

Simple to understand and calculate

Focus on quick recovery of cash, liquidity and risk minimisation

Question 3

Disadvantages of payback

Answer 3

Does not take into account the time value of money
Based on forecasted cash flows so will only be as accurate as the forecast
Ignores cash flow accuring after payback

Question 4

Net Present Value

Answer 4

The sum of all the present values of the future cash flow for a project

Question 5

Advantages of NPV

Answer 5

Uses all the cash flows generated
Gives a greater weighting to the earlier cash which is less risky then the future cash flow
Allows projects with different lengths and different patterns of cash flow to be compare on a common basis

Question 6

Disadvantages of NPV

Answer 6

More difficult to calculate and more difficult to understand
Assumes a constant cost of capital over the project life
Like all capital investment techniques it is based on forecast cash flows
Ignores qualitative, ie, non-financial factors

Question 7

Payback

Answer 7

The time it takes form an investment to return