investment appraisal

Question 1

Advantages of Average Rate Of Return(ARR

Answer 1

It is comparatively easy to use and calculate.
This method is only one which considers profitability which is one of the objectives of the business.
Also, it satisfies owners/shareholders etc

Question 2

dis ARR

Answer 2

• Profit is subjective. It depends on how management has calculated it and might be window-dressed
• does not consider external factors which might affect profitability of project such as
  economic, social and political etc.
• It ignores net cash flows which are more important for survival of business than profits.
• It ignores time value of money. Every dollar received now is more useful to business than dollar
  received at a later date.

Question 3

payback adv

Answer 3

• It is relatively simple to calculate and easy to use.
• It can compare risks of different projects such as Project A with payback of 5 years is considered less
  risky than Project B with payback of 10 years.
• Cash flow is more accurate and less subjective than profitability.
• Shorter payback periods can result in increased liquidity and enable businesses to grow more quickly.

Question 4

dis payback

Answer 4

 This means cash flows after
payback period are ignored which might be negative.
 It ignores time value of money. Though it can be overcome by calculating discounted payback.
 It ignores profitability which is one of the most important considerations of a project for owners of
business.

Question 5

adv NPV

Answer 5

 It gives importance to time value of money. It will take into account that money worth today is not
worth tomorrow.
 It shows how much value will be added to company’s financial position in future.

Question 6

dis NPV

Answer 6

 It is complicated to use and calculate.
 Its usefulness depends on accuracy of cost of capital and future net cash flows. Both can be
manipulated.
 Not useful for comparing projects of different sizes such as $1million investment with investment of
$1000.Thus, will not give accurate comparison if investment of two projects are not equal or similar.
 It will not be useful if project life of two projects under comparison are different.

Question 7

IRR

Answer 7

:It is discount rate at which net present value of a project becomes zero.

Question 8

cost of capital

Answer 8

Cost of capital is the cost of raising finance through debt/equity or both combined.
Also, it shows return investors or lenders expect to earn on investment.
if cost of capital is above IRR then such project will generate
negative NPV and will be rejected

Question 9

senstiivty analysis

Answer 9

It implies analyzing the impact of certain independent variables on dependant variables It shows
maximum change which can be tolerated by business.
.Higher the better and lower the worse.

Question 10

capital rationing

Answer 10

Sometimes business has limited finance thus it cannot invest in all projects. In such case,
business will choose such projects which will generate maximum NPV for it.
NPV/inv cost