Investment Appraisals Flashcards
(9 cards)
1
Q
Payback Period Advantages
A
- Simple, quick and easy to understand.
- Focus is on early payback, can enhance liquidity
- Helps eliminate time risk or reduce exposure
2
Q
Payback Period Disadvantages
A
- Ignores cash flows after payback
- Unable to distinguish between projects with same payback period
- Ignores timing of cash flows within payback period
- Ignores Time value of money
- May lead to excessive investment in short-term projects
3
Q
Accounting Rate of Return formula
A
(Average annual profit from project/ Average Investment) x 100
Profits are calculated after depreciation
4
Q
Advantages of Accounting Rate of Return
A
- Quick and simple to calculate
- Involves a familiar concept of percentage return
- Accounting profits can easily be calculated from financial statements
- Easily understood by non-financial managers and investors because it employs profit
5
Q
Disadvantages of Accounting Rate of Return
A
- Ignores time value of money
- Takes no account of length of project
- Its a relative measure rather than absolute
- Ignores size of investment
- Based on accounting profit which are poor substitutes for cash flow
6
Q
Advantages of Discounted Payback Period
A
- Easy to understand
- Focuses on liquidity
- Takes into account time value of money
7
Q
Disadvantages of Discounted Payback Period
A
- Ignores cash flows that occur after the payback period
- DPB differs from NPV: the discount rate used is unadjusted cost of capital
8
Q
Advantages of Net Present Value
A
- Takes into account time value of money
- Discounts future cash flows at the agreed interest rate
- Most common method used in the business world
9
Q
Disadvantages of Net Present Value
A
- Complicated to calculate
- Difficult to understand/ explain
- Future cash flows and discount rates are uncertain
- Problems with projects with the same NPV
