Topic 6 - Investment Appraisal Flashcards
Capital investment
The investment of capital in non-current assets to help businesses generate profits
Advantages of payback
Simple to understand and calculate
Focus on quick recovery of cash, liquidity and risk minimisation
Disadvantages of payback
Does not take into account the time value of money
Based on forecasted cash flows so will only be as accurate as the forecast
Ignores cash flow accuring after payback
Net Present Value
The sum of all the present values of the future cash flow for a project
Advantages of NPV
Uses all the cash flows generated
Gives a greater weighting to the earlier cash which is less risky then the future cash flow
Allows projects with different lengths and different patterns of cash flow to be compare on a common basis
Disadvantages of NPV
More difficult to calculate and more difficult to understand
Assumes a constant cost of capital over the project life
Like all capital investment techniques it is based on forecast cash flows
Ignores qualitative, ie, non-financial factors
Payback
The time it takes form an investment to return