Project Appraissl

Question 1

What is NPV and how do you calculate it?

Answer 1

Net Present Value (NPV) shows how much value a project adds in today’s money.NPV (Net Present Value) is a method used by businesses to decide if a project is worth investing in.

Sum of cash flow in year t/(1+r)^t - initial cost

You convert that future money into today’s value (because £1 now is worth more than £1 in 3 years)
• Then you subtract the cost of the project

The result is the NPV.

Question 2

What is the Payback Period and how is it calculated?

Answer 2

Payback = Time to recover the initial investment using cash flows.

No if years + remaining amount/last year amount

Question 3

What is IRR and how does it work?

Answer 3

IRR (Internal Rate of Return) is the interest rate that makes a project just break even — in other words, it’s the rate that would make the NPV = 0.
Rule:
• If IRR is higher than the interest rate your business normally wants → Accept the project
• If it’s lower → Reject

Question 4

What is the Payback Period and how do you work it out?

Answer 4

The Payback Period tells you how long it takes to get your money back from a project.

Question 5

What is Discounted Payback Period and how is it different?

Answer 5

Discounted Payback is just like Payback, but more realistic.

It does the same thing — tells you how long to get your money back — but it adjusts for the fact that £1 in the future is worth less than £1 now.

Sum of all cf/1+r^t

Question 6

Which project appraisal method is the best? Why?

Answer 6

NPV is the best method.
Why?
• It uses time value of money
• It focuses on total value added
• It looks at all cash flows, not just the early ones
• It’s the most used in real-world finance and accounting

Question 7

What are the weaknesses of IRR?

Answer 7

You might get more than one IRR if cash flows change direction (e.g. +, –, +)
• It doesn’t show how much value a project creates (just % return)
• It assumes money gets reinvested at the same rate, which is not always realistic
• It can be misleading when comparing different-sized projects

Question 8

What are the weaknesses of Payback and Discounted Payback?

Answer 8

They ignore cash flows after the cut-off point, even if they’re huge
• Payback doesn’t care about time value of money
• Both methods don’t show how profitable the project is — only how fast you recover money
• They’re more about liquidity than value