Investment appraisal Flashcards
What are the advantages of payback period?
Simple, quick and easy to understand
Focus is on early payback can enhance liquidity
An early-stage filter
what are the disadvantages of payback period?
Unable to distinguish between projects with the same payback period
Ignores cash flows after payback
Ignores timing of cash flows within payback period
May lead to excessive investment in short-term projects
Ignores time value of money – goes down over time
what are the advantages of discounted payback period?
Easy to understand
Focus on liquidity
Takes into account time value of money
what are the disadvantages of discounted payback period?
It ignores cash flows that occur after the payback period
We have taken account of the time value of money, but the discount rate used does not take account of project risk and uncertainty
what are the advantages of Accounting Rate of Return (ARR)?
Quick and simple to calculate
Accounting profits can be easily calculated from financial statements
Easily understood by non-financial managers and investors because it employs profit
what are the disadvantages of ARR?
Ignores time value of money
Takes no account of length of project
It’s a relative measure rather than absolute
Based on accounting profits which are poor substitutes for cash flow
what are the advantages of Net Present Value (NPV)?
Considers all the cash flows of the investment over its whole life
Takes into account the time value of money
what are the disadvantages of NPV?
The estimation of the cost of capital may be difficult
Assumes all cash flows occur at the end of the year
Can be complex to calculate
why are future cash flows worth less in today’s money?
inflation
value of money goes down over time
time value of money means that in long term projects, we need to take this into consideration
discount the cash flows occurring in the future to bring them to today’s value
