Investment appraisal techniques

Question 1

Stages of investment decision making:

Answer 1

1. Origination of proposals
2. Project screening
3. Analysis and acceptance
4. Monitor and review

Question 2

the payback period

Answer 2

the time required for the cash inflows to recover the initial cash outflow (ie investment)

Question 3

payback period formula and decision:

Answer 3

payback = initial payment/annual cashflows

Decision rule:
- Payback period < target period = Accept project
- Payback period > target period = Reject project

Question 4

Advantages of payback

Answer 4

• Simple to calculate
• Easy to understand
• Concentrates on early cash flows which are less risky
• Useful for cash strapped companies henca can focus to enhance liquidity

Question 5

Disadvantages of payback

Answer 5

• Doesn’t measure change in shareholder wealth
• Ignores later cash flows
• Requires a target period
• Ignored time value of money
• Unable to distinguish between projects with same payback
• Lead to too many short term projects