Module 5 - Capital Investment Appraisal

Question 1

PPE

Answer 1

positive purpose expenditure

Question 2

NPE

Answer 2

negative purpose expenditure

Question 3

examples of NPE

Answer 3

• redundancy, plant closure costs
• plant mothballing expense
• compensation payments to partners, crystallisation of guarantee obligations

Question 4

Payback

Answer 4

Assesment of the time taken by a project to recover initial capital outlay

Question 5

Advantages of payback

Answer 5

• simple

- easy to see length of time capital is at risk

Question 6

Disadvantages of payback

Answer 6

• doesn’t consider time value of money
• built in discrimination in favour of short term investments
• cash flows after payback ignored
• doesn’t provide measurement of absolute gain of wealth

Question 7

accounting rate of return expresses?

Answer 7

the profits from a project as a percentage of capital costs

Question 8

ARR formuls

Answer 8

AAP/ACI x100

Question 9

AAP

Answer 9

annual cash flows - depreciation / number of years

Question 10

ACI

Answer 10

1/2 (investment + residual value)

Question 11

advantages of ARR

Answer 11

• calculation straightforward

- more easily understood technique

Question 12

disadvantages of ARR

Answer 12

• decision remains subjective
• life of project ignored
• doesn’t account for time value of money
• doesn’t provide a measurement of absolute gain

Question 13

Net present value

Answer 13

evaluates future net cash flows generated by an investment by discounting those flows at a rate which represents the cost to the firm of raising the funds to undertake the invesment

Question 14

After tax cash flows in npv

Answer 14

cash flow x (1-t) where t is tax rates

Question 15

Advantages of NPV

Answer 15

• time value of money
• easy
• exactly measures increase in shareholder’s welath

Question 16

disadvantages of NPV

Answer 16

• Cost of capital only effective discount factor if the potential new investment has the same risk exposure
• can be difficult to understand for non-financial accountants

Question 17

IRR

Answer 17

rate of return on the project (calculated as the rate that brings the net present value of all inflows and outflows to zero)

Question 18

if IRR > cost of capital

Answer 18

increase shareholders wealth

Question 19

advantages of IRR

Answer 19

easier to understand than NPV

- time value of money

Question 20

disadvantages of IRR

Answer 20

• more difficult to understand
• if there are changes in direction of cash flow may need more than one IRR
• may give different rankings to NPV, use NPV when this occurs

Question 21

Capital rationing

Answer 21

used when unable to undertake all profits which have a positive NPV,

always maximise NPV