Capital investment appraisal

Question 1

How do you work out payback period?

Answer 1

Need 2 columns, cashflow and cumulative cashflows.

Cashflows = what will be received as cashflows each year, start with year 0 as the investment as a negative USE NORMAL CF, NOT DISCOUNTED ONES

Cumulative cashflows = add up the cashflows going down the list

Payback = the year in between the last negative cumulative cash flow and the first positive cumulative cash flow (WILL BE THE LAST NEGATIVE YEAR AS THE YEAR OF PAYBACK)

Payback month = (last -ve cum. cf/ first +ve normal cf) * 12

Question 2

How do you calculate NPV?

Answer 2

initial investment (as a negative) + all cash flows

Question 3

How do you calculate IRR?

Answer 3

1. Calculate NPV at a diff. discount rate
2. (original NPV/ decrease in NPV) * increase in % = additional %
3. Additional % + original %

Question 4

How do you capital ration for single periods?

Answer 4

Use Profitability index (PI)

= PV/ investment outlay

Question 5

How do you complete a capital investment appraisal question?

Answer 5

1. Calculate WDAs
   (year, annual WDA, WDV - year 0 = starting cash flow) (the last year is the scrap value as the WDV so will need a balancing figure)
2. Calculate taxable profit and then tax
   (year (will need 1 more than asked), demand, contribution (SP - VC * demand), less: FC, less: WDA, taxable profit, less: tax (delay by 1 year, put them in as negatives)
3. Calculate working capital
   (year, working capital required, cash flow (year 0 - negative of amount required, next years are difference between the WC required, will be negative, WC added back to last year so +ve).
4. Calculate net cash flows
   (year, machine (add in investment to year 0, add scrap value to last year), profit (taxable profit+ WDA), working capital cash flows (INITIAL WC NEEDED TAKEN FROM YEAR 0), tax (delay it), cash flows)
5. Discount cash flows and calculate NPV
   (year, cash flows, discount factor, discounted cash flows, NPV)
6. Calculate IRR