06 - Investment Appraisal Flashcards
1
Q
What are the learning outcomes of the chapter on Long-Term Investments?
A
- Explain the process of valuing long-term investments.
- Calculate the net present value, internal rate of return and payback for an investment.
2
Q
What methods of appraisal can be used to assess investments?
A
Payback
NPV
IRR
- Requires linear interpolation
- L + NL / (NL - NH) * (H - L)
- L - Lower discount rate
- H - Lower discount rate
- NL - NPV calculated using lower rate
- NH - NPV calculated using higher rate
3
Q
What are the advantages and disadvantages of using the payback method?
A
Advantages
- Very simple to calculate
- Measures financial exposure period of company (risk time)
- Gives some weighting to timing of cash flows as earlier cash inflows will decrease payback period
Disadvantages
- Takes no account of cash flow size after initial investment has been recovered.
- Does not adequately reflect timing importance of cash flows.
- If used as sole evaluation method, makes short term investment look more attractive.
4
Q
What are the advantages and disadvantages of the NPV method?
A
Advantages
- Allows for the time value of money
- Considers the whole life of the project, not just the payback period.
- Will usually allow the manager to arrive at the correct accept/reject decision because NPV reflects the increase or decrease in wealth arising from the investment.
Disadvantages
- Can be difficult for managers to understand.
- Determining the required rate is complicated.
5
Q
What are the advantages and disadvantages of the IRR method?
A
Advantages
- Allows for the time value of money
- Considers the whole life of the project, not just th payback period.
Disadvantages
- Does not measure the absolute wealth created.
- A high rate on a small investment will look attractive even though the total generated will still be small.
- IRR could lead to the wrong choice being made between two project.
6
Q
A
